Dow Jones Shanghai Index broke support at 440. Expect more government efforts, near the close, to shore up support. As futile as attempting to hold back the tide. Target for the breakout is 330*.
* Target calculation: 440 – ( 550 – 440 ) = 330
Australian Dollar during the 1997 Asian financial crisis
Performance of the Australian Dollar during the Asian financial crisis. The falling Dollar acted as a buffer, protecting the Australian economy from the Asian contagion.
A similar 25% fall from today’s 72 US cents would offer a target of 54 US cents. No science to this. Simply speculation.
A bad case of the ‘nineties
The 1990s featured two significant upheavals in global financial markets. First, 1990 saw the Nikkei collapse from its high of 39000, reaching an eventual low of 7000 in 2008.
The collapse followed strong appreciation of the Yen after the September 1985 Plaza Accord and the ensuing October 1987 global stock market crash. The Plaza Accord attempted to curtail long-term currency manipulation by Japan who had built up foreign reserves — mainly through purchases of US Treasuries — to suppress appreciation of the Yen against the Dollar and maintain a current account surplus.
Seven years later, collapsing currencies during the 1997 Asian financial crisis destroyed fast-growing economies — with Thailand, South Korea and Indonesia experiencing 40%, 34% and 83% falls in (1998) GNP respectively — and eventually led to the 1998 Russian default and break up of the Soviet Union. Earlier, rapidly growing exports with currencies pegged to the Dollar brought a flood of offshore investment and easy credit into the Asian tigers. Attempts by the IMF to impose discipline and a string of bankruptcies spooked investors into a stampede for the exits. Falling exchange rates caused by the stampede led to a further spate of bankruptcies as domestic values of dollar-denominated debt skyrocketed. Attempts by central banks to shore up their currencies through raising interest rates failed to stem the outflow and further exacerbated the disaster, causing even more bankruptcies, with borrowers unable to meet higher interest charges.
What we are witnessing is a repeat of the nineties. This time it was China that attempted to ride the dragon, pegging its currency against the Dollar and amassing vast foreign reserves in order to suppress appreciation of the Yuan and boost exports. The Chinese economy benefited enormously from the vast trade surplus with the US, but those who live by the dragon die by the dragon. Restrictions on capital inflows into China may dampen the reaction, compared to the 1997 crisis, but are unlikely to negate it. The market will have its way.
Financial markets in the West are cushioned by floating exchange rates which act as an important shock-absorber against fluctuations in financial markets. The S&P 500 fell 13.5% in 1990 but only 3.5% in October 1997. The ensuing collapse of the ruble and failure of LTCM, however, caused another fall of 9.0% a year later. Not exactly a crisis, but unpleasant all the same.
North America
The domestic US economy slowed in the past few months but increased spending on light motor vehicles and housing suggested that robust employment growth would continue. Upheaval in financial markets (and exports) now appears likely to negate this, leading to a global market down-turn.
The S&P 500 breached primary support at 1980, signaling a primary down-trend. The index has fallen 4.5% from its earlier high and presents a medium-term target of 1830*. Decline of 13-week Twiggs Money Flow below zero would confirm the signal but descent has been gradual, suggesting medium-rather than long-term selling pressure.
* Target calculation: 1980 + ( 2130 – 1980 ) = 1830
The CBOE Volatility Index (VIX) spiked upwards indicating rising market risk.
Bellwether transport stock Fedex broke primary support at $164, confirming the primary down-trend signaled by 13-week Twiggs Money Flow reversal below zero. The fall warns of declining economic activity.
Canada’s TSX 60 broke primary support at 800, confirming the earlier bear signal from 13-week Twiggs Momentum reversal below zero. Target for a decline is 700*.
* Target calculation: 800 – ( 900 – 800 ) = 700
Europe selling
Germany’s DAX broke medium-term support at 10700. Expect further medium-term support at 10000 but reversal of 13-week Twiggs Money Flow below zero warns of selling pressure. Breach of 10000 would indicate a test of primary support at 9000.
* Target calculation: 10700 – ( 11800 – 10700 ) = 9600
The Footsie broke 6450, signaling a test of primary support at 6100. Reversal of 13-week Twiggs Money Flow below zero warns of (long-term) selling pressure. Breach of 6100 would offer a target of 5000**.
* Target calculation: 6450 – ( 6800 – 6450 ) = 6100 **Long-term: 6000 – ( 7000 – 6000 ) = 5000
Asia
The Shanghai Composite reflects artificial, state-backed support at 3500. Declining 13-week Twiggs Money Flow warns of long-term selling pressure. Withdrawal of government support is unlikely, but breach of 3400/3500 would cause a nineties-style collapse in stock prices.
* Target calculation: 4000 – ( 5000 – 4000 ) = 3000
Japan’s Nikkei 225 appears headed for a test of 19000. Breach would test primary support at 17000 but, given the scale of BOJ easing, respect is as likely and would indicate further consolidation between 19000 and 21000. Gradual decline of 13-week Twiggs Money Flow suggests medium-term selling pressure.
* Target calculation: 21000 + ( 21000 – 19000 ) = 23000
India’s Sensex is holding up well, with rising 13-week Twiggs Money Flow signaling medium-term buying pressure. Breakout above 28500 is unlikely but would indicate another test of 30000. Decline below 27000 would warn of a primary down-trend; confirmed if there is follow-through below 26500.
Australia
Commodity-rich Australian stocks are exposed to China and emerging markets. The only protection is the floating exchange rate which is likely to adjust downward to absorb the shock — as it did during the 1997 Asian crisis. 13-Week Twiggs Money Flow below zero warns of (long-term) selling pressure on the ASX 200. Breach of support at 5150 is likely and would confirm a primary down-trend. Long-term target for the decline is 4400*. Respect of primary support is unlikely, but would indicate consolidation above the support level rather than a rally.
China’s dangerous currency manipulation
I am surprised at John Mauldin’s view in his latest newsletter Playing the Chinese Trump Card:
….This whole myth that China has purposely kept their currency undervalued needs to be completely excised from the economic discussion. First off, the two largest currency-manipulating central banks currently at work in the world are (in order) the Bank of Japan and the European Central Bank. And two to four years ago the hands-down leading manipulator would have been the Federal Reserve of the United States.
John is correct that China has in recent years engaged in less quantitative easing than Japan, Europe and the US. And these activities are likely to weaken the respective currencies. But what he ignores is that these actions are puny compared to the $4.5 Trillion in foreign reserves that China has accumulated over the last decade. That is almost 2 years of goods and services imports — far in excess of the 3 months of imports considered prudent to guard against trade shocks. Arthur Laffer highlights this in his recent paper Currency Manipulation and its Distortion of Free Trade:
Accumulation of excessive foreign reserves is the favored technique employed by China, and Japan before that, to suppress currency appreciation over the last three decades. Dollar outflows through capital account, used to purchase US Treasuries and other quality government and quasi-government debt, are used to offset dollar inflows from exports. This allows the exporting state to maintain a prolonged trade imbalance without substantial appreciation of their currency. And forces the target (US) to sustain a prolonged trade deficit to offset the capital inflows. Laffer sums up currency manipulation as:
….. when a country either purchases or sells foreign currency with the intent to move the domestic currency away from equilibrium or to prevent it from moving towards equilibrium.
Even Paul Krugman (whose views I seldom agree with) has been wise to the problem for at least 5 years:
…..economist Paul Krugman and a group of senators led by New York Democrat Chuck Schumer wanted to impose a 25% tariff on Chinese imports.
Prolonged current account imbalances cause instability in global financial markets. A sustained US current account deficit was one of the primary weaknesses cited by Nouriel Roubini in his forecasts of the 2008 financial crisis (the other side of the equation was a sustained Chinese surplus). But currency manipulation is not only dangerous, it is also short-sighted. International trade is a zero-sum game. For every dollar of goods, services, capital or interest that goes out, a dollar of goods, services, capital or interest must come in. For every country that runs a current account surplus, another must run a deficit. Without international regulation, each country will try to engineer a trade surplus in order to boost their domestic economy at the expense of their trade partners. An endless game of beggar-thy-neighbor.
Participants will suffer long-term consequences. The power of financial markets is unstoppable. Central banks attempt to hold back the tide, distorting price signals and shoring up surpluses (or deficits), at their peril. The market will have its way and restore equilibrium in the long term. As Japan in the 1990s and Switzerland recently experienced, the further you move markets away from equilibrium the more powerful the opposing backlash will be. The scale of China’s market manipulation is unprecedented, and caused large-scale distortions in the US. The end result forced the Fed to embark on unprecedented quantitative easing which, in turn, is now impacting back on China.
The impact will not only be felt by China, as John points out:
The low rates and massive amounts of money created by quantitative easing in the US showed up in emerging markets, pushing down their rates and driving up their currencies and markets. Just as [governor of the Central Bank of India, Raghuram Rajan] (and I) predicted, once the quantitative easing was taken away, the tremors in the emerging markets began, and those waves are now breaking on our own shores. The putative culprit is China, but at the root of the problem are serious liquidity problems in emerging markets. China’s actions just heighten those concerns.
Chinese hopes for a soft landing are futile.
Currency Manipulation and its Distortion of Free Trade | A B Laffer
Extract from Arthur B. Laffer’s paper on currency manipulation:
….Successful currency manipulation inhibits the exchange rate from acting as an automatic stabilizer to macroeconomic events, and thereby leads to growth and trade imbalances. Currency manipulation has therefore, in part, inhibited the world from fully recovering from the financial crisis. For instance, real growth has been tepid at best for developed countries that do not intervene in the foreign exchange market, while countries that have been identified as currency interventionists have experienced a much steadier pace of recovery from the financial crisis—this has been dubbed as the two-speed global recovery.
The two-speed recovery has shown, in part, that persistent currency undervaluation has benefited the currency manipulators at the expense of countries allowing the flexible adjustment of exchange rates, since the latters’ export-related activities must quickly respond to the external balances caused by trading partners’ currency devaluations. As of 2012, the scope of currency manipulation is estimated to be approximately $1.5 trillion per year, with about 60 percent of these flows channeling into dollar assets. Moreover, the impact of currency manipulation has potentially dampened the U.S. current account by about 4 percent of GDP in 2012, which was approximately the size of the U.S. output gap in the corresponding year. While providing an exact number of U.S. jobs lost due directly to currency manipulation is tricky, it is likely that millions of jobs in the U.S. were lost as a result of current account imbalances that were generated, in part, by currency manipulation.
These spillover effects would likely disappear if exchange rates were liberalized to better exhibit market fundamentals, which would also potentially improve welfare in undervalued currencies’ economies by improving domestic demand. In fact, further movement toward freely floating exchange rates and the removal of capital account restrictions will help rebalance global growth, which in turn will reduce financial and economic risk. Moreover, research has found that future financial crises can be, in part, predicted by large current account imbalances as such distortions suggest the misallocation of capital. In fact, earlier studies from Laffer Associates confirm this link between current account imbalances and financial crises helped explain the Asian currency crisis in the late 1990’s.
Considering the employment and economic impact of currency manipulation on the United States and given that the United States is negotiating a free trade agreement, the Trans-Pacific Partnership (TPP), to avoid further harm and ensure the agreement’s benefits aren’t undermined by countries that have a history of manipulating their currencies, it is vital that the TPP include defined monetary policy standards and a means to identify currency manipulators and enforce violations…..
Read more at Currency Manipulation and its Distortion of Free Trade | A B Laffer
Desperate times, desperate acts
A sharp fall in global trade is the most likely reason for China’s decision to devalue the Yuan — not aspirations for CNY to be considered a reserve currency.
There are clear signs that global trade is contracting. Shipbrokers Harper Petersen’s Harpex weekly index of charter rates for container vessels fell 9 percent in July and August is following a similar path. Reduced demand for container shipping reflects a sharp fall-off in international trade in manufactured goods.
Tyler Durden from zerohedge.com highlighted China’s falling exports last week (August 8):
Goldman breaks down the geographic slowdown:
- Exports to the US contracted 1.3% yoy, down from the +12.0% yoy in June.
- Exports to Japan fell 13.0% yoy in July, vs -6.0%yoy in June
- Exports to the Euro area went down 12.3% yoy, vs -3.4% yoy in June.
- Exports to ASEAN grew 1.4% yoy, vs +8.4% yoy in June
- Exports to Hong Kong declined 14.9% yoy, vs -0.5% yoy in June.
Slower sequential export growth likely contributed to the slowdown in industrial production growth in July. Weaker export growth is likely putting more downward pressure on the currency, though whether the government will allow some modest depreciation to happen remains to be seen.
Durden presciently concludes:
As global trade continues to disintegrate, and as a desperate China finally joins the global currency war, it will have no choice but to devalue next.
Michael Leibowitz at 720Global.com also warns of the destabilizing effect carry trades may have on any adjustment:
The “one-off” adjustment has now become two…. this devaluation is likely not a one-time event but rather the beginning of an ongoing and persistent depreciation of the CNY versus the USD. The embedded USD short position within the [estimated $2Tn to $3Tn] carry trades will begin to result in losses and margin calls as the USD appreciates versus the CNY, thus forcing investors to liquidate some of their positions. These trades, which took years to amass, could unwind abruptly and exert an influence of historic magnitude on markets and economies.
Read more at 1997 Asian Currency Crisis Redux | Zerohedge.
Let the Global Race to the Bottom Begin | Foreign Policy
Patrick Chovanec writes:
On Aug. 11, the People’s Bank of China announced a decision to devalue China’s currency — the renminbi, or RMB — by 1.9 percent, by resetting the daily band within which it’s traded…..
The Chinese will try to argue they are just letting the market have its way. This is misleading: For years, the Chinese prevented the RMB from rising in value by buying nearly $4 trillion in foreign currency. The current market “equilibrium” is predicated on that massive distortion. The only way to get to a truly market-based RMB is to first unwind China’s past intervention by supporting the RMB and drawing down China’s foreign currency reserves. We shouldn’t want the RMB to float until that happens…..
Read more at Let the Global Race to the Bottom Begin | Foreign Policy.
China: Deja vu all over again
The Shanghai Composite today found support at 3500 today after plunging more than 8% on Monday. The large divergence on 13-week Twiggs Money Flow continues to warn of selling pressure.
* Target calculation: 4000 – ( 5000 – 4000 ) = 3000
Japan’s Lost Decade
From Wikipedia:
The Japanese asset price bubble….. was an economic bubble in Japan from 1986 to 1991 in which real estate and stock market prices were greatly inflated. The bubble was characterized by rapid acceleration of asset prices and overheated economic activity, as well as an uncontrolled money supply and credit expansion. More specifically, over-confidence and speculation regarding asset and stock prices had been closely associated with excessive monetary easing policy at the time.
By August 1990, the Nikkei stock index had plummeted to half its peak by the time of the fifth monetary tightening by the Bank of Japan (BOJ)…..the economy’s decline continued for more than a decade. This decline resulted in a huge accumulation of non-performing assets loans (NPL), causing difficulties for many financial institutions. The bursting of the Japanese asset price bubble contributed to what many call the Lost Decade.
“…uncontrolled money supply and credit expansion….overheated stock market and real estate bubble.” Sound familiar? It should. We are witnessing a re-run but this time in China. Wait, there’s more…..
…..At the end of August 1987, the BOJ signaled the possibility of tightening the monetary policy, but decided to delay the decision in view of economic uncertainty related to Black Monday (October 19, 1987) in the US.
…..BOJ reluctance to tighten the monetary policy was in spite of the fact that the economy went into expansion in the second half of 1987. The Japanese economy had just recovered from the “endaka recession” ….. closely linked to the Plaza Accord of September 1985, which led to the strong appreciation of the Japanese yen.
…..in order to overcome the “endaka” recession and stimulate the local economy, an aggressive fiscal policy was adopted, mainly through expansion of public investment. Simultaneously, the BOJ declared that curbing the yen’s appreciation was a “national priority”……
Global stock market crash leads to prolonged monetary easing…… aggressive expansion of public investment to stimulate the domestic economy…..central bank efforts to curb appreciation of the currency. We all know how this ends. We’ve seen the movie before.
It’s like deja-vu, all over again. ~ Yogi Berra
Chinese Manufacturing Activity Falls in July – The New York Times
From Reuters:
BEIJING — China’s factory sector contracted by the most in 15 months in July as shrinking orders depressed output, a preliminary private survey showed on Friday, a worse-than-expected result that should reinforce bets the struggling Chinese economy will get more stimulus.
The flash Caixin/Markit China Manufacturing Purchasing Managers’ Index (PMI) dropped to 48.2, the lowest reading since April last year and a fifth straight month below 50, the level which separates contraction from expansion.
Read more at Chinese Manufacturing Activity Falls in July – The New York Times.
Japan Escalates Its Standoff With China in the South China Sea | VICE News
By Jennifer Peters
July 22, 2015 | 8:45 am
Japan has put its foot down — at least in writing — over China’s attempts to assert greater control of the South China Sea.
….Japan isn’t the only one pushing back against China’s expansion in the region. The Philippines is taking China to court over territorial claims to the South China Sea, with top Filipino officials appearing at The Hague to argue their case before a United Nations arbitral tribunal. China has called it a “political provocation.”
“The Chinese take kind of a Leninist approach to these things,” [Kelley Currie, a senior fellow with the Project 2049 Institute] said. “They probe with the bayonet until they hit steel, and then they’ll stop. When they start to see that people are serious about pushing back, then they will back off a bit.”
Read more at With a Few Words, Japan Escalates Its Standoff With China in the South China Sea | VICE News.