Darien, Connecticut
Dear Reader,
We covered the topic in yesterday’s Daily Reckoning, but it bears repeating…
China is going broke. How do I know? It’s second-grade math. Let’s go over it again. China started 2014 with over $4 trillion in reserves. By the end of 2016, the reserve number had fallen to $3 trillion. This was due to capital flight in various forms, legal and illegal, including debt repayment.
About $1 trillion of the remaining reserves are illiquid (for example, hedge fund investments made by China Investment Corp., the sovereign wealth fund). Another $1 trillion must be held as a precautionary reserve to bail out China’s banks, which are facing a wave of bad debts from state-owned enterprises and property speculators.
That leaves $1 trillion free and clear to defend the currency. Ongoing capital flight is depleting that remaining $1 trillion at a rate of about $80 billion per month. This means China will be out of liquid reserves, and effectively broke as an international trading partner, by the end of 2017.
Of course, this will not be allowed to occur. Instead, China will slap on further capital controls and devalue their currency. This is already happening with a twist. China wants banks to impose capital controls but keep it a secret.
Instead, China will slap on further capital controls and devalue their currency.
Why the secrecy?
Because China does not want the world to know what a desperate situation it’s in. Secrecy won’t help, though. The math is still the math. China is still going broke, and the resulting crisis will not be contained.
It comes back to the “Impossible Trinity.”
The “Impossible Trinity” is an economic concept developed by the great economist Robert Mundell in the early 1960s.
Mundell said that a country could not have an open capital account, fixed exchange rate and an independent monetary policy all at the same time without causing a reserve crisis. The idea is that if you have interest rate differentials (due to independent monetary policy) and peg your currency, then capital will flow from the low-yield to the high-yield country.
At some point, these outflows will cause a reserve crisis or cause the pegged exchange rate to break, resulting in a foreign exchange crisis. There are various other outcomes under Mundell’s framework, including precautionary capital flight. The point is that trying the impossible trinity is bound to fail.
China is proving this again today.
They are trying to run an open capital account, maintain independent monetary policy and peg the yuan to the dollar within a range. This policy is failing in multiple ways.
Capital outflows are huge, and downward pressure on the yuan is relentless all in anticipation of a maxi-devaluation.
China is heading for a reserve crisis or a foreign exchange crisis, or both. This will once again prove that the impossible trinity is indeed impossible.
Below, I take you on a deeper dive into the “Impossible Trinity.” Think of China as you absorb the information and realize why it’s heading for crisis. Read on.
Regards,
Jim Rickards
for The Daily Reckoning
Editor’s note: A massive new currency shock could be just days away...
It could happen as soon as this Friday… the day Trump takes office… that’s when this new massive currency shock could take place. To the best of my knowledge, no one else is talking about this.
This shock has been at the center of my currency war thesis for a long time now. But we could be rapidly approaching a turning point that has vast implications for your financial future.
Click here now and read the urgent details. You may have only days to prepare for what’s coming.
And I want to help navigate you through what’s coming with a free broadcast tomorrow, Wednesday, Jan. 18, at 7 p.m. EST.
www.fotavgeia.blogspot.com
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