Easy button -- Arthur Hayes

China vs. Japan vs. America

There’s a delicate relationship between Japan, China, and the US

• Japan and China both compete to export goods

• USDJPY has gotten out of control lately, making Japanese exports much more attractive

  • However, Japan desperately wants to strengthen the Yen

• China is dealing with deflation and a not-so-hot economy

• USDCNY has been pegged, making their situation trickier to get out of

Hayes shares his view and a potential solution out - all of which result in increases in global liquidity

In more detail:

• USDJPY has rallied tremendously - Japan needs contain this given that they are a net importer. They have two options:

  • Sell US treasuries and buy JPY

  • Force regulated pools of capital to buy Japanese bonds

• US doesn’t want Japan to sell treasuries since this would potentially wreck the US treasury market

Japan’s situation

• The bank of japan is the largest holder of Japanese government bonds (JGBs)

• If rates rise, Bank of Japan (BoJ) will have a lot of losses on their balance sheet

• But with the interest rate diff, ppl will borrow the yen and long USD (carry trade)

  • This pushes USDJPY up even more

China’s situation

• How does China come into the mix?

  • China and Japan directly compete on exports

  • If the CNYJPY rises, China’s ability to export is damaged

• China is in a terrible situation with negative real GDP over the last few years

  

  • This creates a vicious spiral

    • Asset prices fall →

    • Assets are used as collateral →

    • Forced debt repayment which requires more selling pressure on assets

• Chinese monetary printing presses (credit creation) hasn’t been enough to offset

• So why doesn’t China just outright devalue the CNY?

  • Hayes thinks they don’t want to mess with the USD pair as this may intensify capital flight or increase import costs

  • China imports food + energy; “The lesson that any Marxist esp a Chinese one takes away from the history of revolutions is to never let rate of food + energy inflation get out of control”

• For America, a stronger USDCNY pair would be bad for reshoring manufacturing

  • Why establish domestic factories and labor when it costs so much more?

Election woes

• To build on that last point, the emphasis on reshoring manufacturing is sensitive to Biden with the elections comping up

  • Biden recently announced a raise on tariffs on various Chinese goods

• However, there is a loophole where goods aren’t shipped directly from China but crossing a US export friendly country (e.g. Vietnam, Mexico)

  

  See how much exports from Mexico/Vietnam have grown (yellow/white)

China’s Move

• From China’s PoV, if USDJPY doesn’t devalue, China will begin devaluing CNY relative to USD and consequently exporting its deflation to the rest of the world (cheap goods in massive quantities)

• China is pressuring US to weaken the $ (so that they can start increasing their credit)

  • In return, China will keep the USDCNY stable and agree to limit the amount of product it ships to America as well

• China also holds a shit ton of gold (31K tonnes, 2.34T in today’s prices)

• The yuan has a 6% backing by gold, and 8% backing by foreign reserves

• Hayes thinks China has a check mate here

  • Sell US treasuries for gold

  • Declare a rough peg between CNY and gold

  • As price of gold rises, this will negatively affect a lot of financial institutions which could have a contagion affect wrecking the global financial system

  • Fed inevitably bails everyone out by printing $

• The assumption here is that the US can pressure Japan in strengthening the yen

  • Japan has done this to reduce export competitiveness in the 70s and 80s

Japanese Bond Math 

• So how can BoJ strengthen the JPY?

  • Raise rates outright

  • Get regulated capital to sell US denominated assets and buy JGBs

• BoJ owns a ton of JGBs

• If they outright raise rates, the BoJ gets wrecked (rates up means bond prices down)

• BoJ owns 585.2T yen worth of bonds with 32.25B worth of capital

• Instead of raising rates outright, they need to get regulated pools of capital to buy JGBs (selling their foreign dollar denominated assets)

• This is not a great outcome for the US as it adds selling pressure on treasuries (pushing rates further up)

Easy Button

• So what is the easy button that Hayes was alluding to?

  • Fed swaps a trillion USD → yen

  • The Fed has no use for yen, which effectively is out of the system

  • BoJ gets 1T of USD that they use, releases it into global markets

  • This effectively weakens the dollar against all currencies

  • China is happy since this means they can print money while maintaining a peg

  • Supply of CNY increases while JPY decreases (its on the US balance sheet)

  • Now any dollar based asset rises (more $ in system)

  • Everybody wins?

• How is this different from yield curve control (YCC)?

  • YCC is when a central bank prints infinite amounts to buy bonds in order to set a price + yield (supply of $ increases, weakening the currency)

  • With the dollar yen swap (described above), the Fed is effectively printing and implicitly adding buy pressure on bonds (Japan doesn’t sell US treasuries)

  • In both cases, US treasury yields are lower than they would be otherwise (dollar is weaker)

  • This options is more “hidden” and doesn’t require explicitly permission from congress

  • The risk is that it does become clear to everyone and the US dollar strength tanks very fast

Invalidation

• Two scenarios where this is invalidated

  • BoJ is addresses the weak yen by raising rates substantially (2% or more)

• And/or the yen continues to weaken and the US / Japan do nothing

• If either of these happen, we eventually get an explicit yield curve control policy by the US

Timing is Everything

• Market knows the yen is weak - Hayes thinks it continues to weaken into the fall

• With US election coming up, Biden really needs to come to a solution

• USDJPY surge to 200 would be enough to push the button

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