Jiang Zemin Warns on Political Crackdown

Keeping in line with what I posted yesterday:

Ex-president Jiang urges Beijing to curb anti-corruption drive
Jiang Zemin, the former Chinese president, has urged the current leadership to rein in the toughest anti-corruption campaign in decades, which is threatening the interests of some Communist party elders.

Mr Jiang, who stepped down as president of China in 2003 but retained control of the military for a further two years, has sent a clear signal in the past month to Xi Jinping, the president, according to three people familiar with the matter.

Mr Jiang sent a message saying “the footprint of this anti-corruption campaign cannot get too big” in a warning to Mr Xi not to take on too many of the powerful families or patronage networks at the top of the party hierarchy.

.....Most global luxury companies have reported declining Chinese sales of their products, which have been favoured as gifts and bribes for officials for years.

In the past few weeks, producers of high-end spirits like Diageo, Pernod Ricard and Rémy Cointreau have reported double-digit first-half collapses in sales in China and have explicitly blamed Beijing’s austerity drive for their woes.
This is the beauty of a slowdown in the economy. They won't have to use political means to out the corrupt, they don't need to mount huge investigations (though they needed one to take apart Zhou Yongkang network). Xi and Li's political enemies will be exposed when firms under their control go bankrupt. Their enemies don't even need to be corrupt: mismanaging a state-owned company will destroy a politician's political power. Xi and Li will also be able to point to the example of Zhou Yongkang, a case of killing the chicken and letting the monkeys watch. Then when it comes time to pass economic reforms, Xi and Li will find their political enemies are great supporters of their market oriented reforms.

Changzhou Dubbed the Second Ghost City; A Minefield of Oversupply

Changzhuo in Jiangsu province has been dubbed the second ghost city in China. The headline goes on to say there are buildings everywhere, but no cars. 常州房屋过剩已成“鬼城”第二 遍地只见住宅不见车辆

This headline blares: Developers flee Changzhou "minefield"
In some real estate view, Changzhou belongs to the danger zone, there has been the problem of excessive supply. According to the same data show policy advisory body, Changzhou local property buyers just need customer satisfaction, in the past 13 months and 9 months of commercial housing oversupply. Over the past year, the average price of commercial housing turnover Changzhou widespread in 6000-7200 yuan / square meter, but in January 2014, the average price of commercial housing turnover Changzhou only 6009 yuan / square meter, a record low since last year.

Here will build a new "world-class" theme park, business district, etc., while still under construction subway. But among Changzhou Makeovers plan, the most ambitious to the number of its large number of residential projects. According to the "First Financial Daily" reported that, according to Changzhou, about 460 million of the total population, nearly four years, per capita Changzhou new construction area of ​​20 square meters, this value ranking in all domestic cities.

The mainland media was picking up on South China Morning Post reports.

Developers' big dreams for smaller mainland China cities falling apart
The developers were betting that lower land prices and the huge growth potential in such cities could generate attractive returns, but the influx of property investment led to chronic oversupply problems.

As a result, developers have been forced to cut prices, some by more than a third in Changzhou, Hangzhou, Nanjing, Ningbo and Qinhuangdao.

The South China Morning Post recently visited the two cities where the first price cuts were seen this year: Changzhou in Jiangsu province, and Hangzhou in Zhejiang.

The huge unsold housing inventories in the two cities could take 22 months to unload, according to industry observers, compared with the normal 12 to 15 months.

"The Changzhou property market is horrible," said Yang Quanqiao, a director for development at Centaline (China).

Yang said land to be sold in coming years could yield 85 million square metres of gross floor area in Changzhou - which has a population of about 4.5 million - enough to build 850,000 100-square-metre flats.

"Changzhou is a small city with limited investor demand," he said. "The supply will probably be enough for 10 years."

Alarm grows over housing supply glut in inner mainland China cities
"You can find a lot of evidence for a negative outlook. For example, some projects have cut prices, others can't sell and then there are these ghost towns," he said. "Many cities have unsold properties that will take over a year to clear. That is alarming. But it will give competitive developers room to buy land parcels as some will leave the market."

He said Vanke would not open any new pipelines of projects this year because of oversupply fears. "But the oversupply can be absorbed over time. There shouldn't be any big problems," he said.

Another local developer, who requested not to be named, said it usually took Changzhou residents about two to three years to move in after they got the keys.

"Owners usually take one or two years for decoration and leave the newly painted flat empty for a year until all the chemical smell is gone, especially buyers with children. We disagree that Changzhou is a ghost town. Outsiders just don't understand Changzhou residents' lifestyle," said the developer.

PBOC Shuts Down Stimulus Talk

The PBOC puts the kibosh on the reserve requirement cut talk. It isn't happening, at least not yet. The bank will stick with open market operations and stay the course on the deleveraging process.

Out this afternoon in China:
Li Warns of Risks as Yields Drop Most Since Lehman: China Credit
Premier Li’s warning, given at a meeting last week, that China can’t ignore the dangers of increasing downward pressure on the economy has spurred bets the government will roll out measures to stabilize growth as indicators such as manufacturing signal a slowdown. As part of the initial steps, the People’s Bank of China may cut lenders’ reserve requirement for the first time since May 2012, according to Credit Suisse Group AG and Nomura Holdings Inc.

That is typical of the stimulus talk going around.

This was posted a couple of hours earlier on "Chinese Financial News," a PBOC publication: 中国经济需要“降准”来刺激吗 (Does the PBOC need to stimulate the Chinese economy with rate cuts?)
To lower or not lower the deposit reserve ratio? Currently described each see different views.

Advocated "RRR" by two reasons:

First, the new foreign exchange 128.246 billion yuan in February, not only significantly reduced compared with 309.1 billion yuan in January 437.366 billion yuan, also hit a new low since last September. In particular, since March 17 RMB exchange rate volatility expanded from 1% to 2%, the RMB spot rate bidirectional intraday volatility and depreciation is expected to increase. Some people worry that the continued depreciation of the RMB will lead to hot money inflows power weakened, slowing growth in foreign exchange. "If a month or a month or two of negative growth in foreign exchange occurs, the central bank must lower the deposit reserve ratio." Idea that.

The second is from 1 to February data show a significant slowdown in China's economic growth momentum. Performance of China's industrial added value growth rate declined from 9.7% in December last year to February this year, from 1 to 8.6 percent, the lowest in five years; social consumer goods retail sales growth fell from 13.6% in December last year to a ~ February's 11.8 percent, the lowest in nearly 10 years; urban fixed asset investment up 19.6% from last year's growth rate fell to 1 to 17.9% in February, the lowest in nearly 12 years; 1 to 2 months the national total electricity the amount of accumulated 824.3 billion kwh, an increase of 4.5%, lower than last year by 1 percentage point. The latest HSBC in March China's manufacturing purchasing managers index (PMI) fell to preview data is 48.1%, the highest eight-month low. Economic data is not to force, so many economists believe, must adopt a new round of economic stimulus. The lower the deposit reserve ratio, continue to turn on the water, seems to be one of the best choices.

Argument against "drop quasi" who is also very good: the experience of the last few years has repeatedly proven, monetary policy stimulus effect on the economy is not sustainable and are getting shorter. For example, the policy began in the spring of 2012, to relax, only about one year to support the economic rebound in 2013 after a significant slowdown in the economy began in the spring. While easing the summer of 2013, only a period of less than six months to support the economic rebound. Moreover, lowering standards and credit expansion is difficult to stimulate the economy, structural imbalances will actually worsen even make the asset price bubble continues to inflate.

Appear diametrically opposite view is not surprising. Whenever the Chinese economic slowdown, CPI decline economists out there, "RRR" prescription. So last year, this year is no exception.

In fact, you do not "drop quasi", the first to look at the tight liquidity in the banking system is not tight, followed by watching "RRR" There is no use, how far-reaching effects.

In the former case, the current "volatility of money market interest rates remain downstream market, the overall liquidity of the banking system is more moderate." On the open market, after seven weeks, the central bank in the open market funds were net return of 48 billion yuan, 40 billion yuan, 70 billion yuan, 160 billion yuan, 108 billion yuan, 450 billion yuan and 98 billion yuan, the overall return of moderate intensity, Each term interbank interest rates low for the overall market, although a slight rise in interest rates at the end, but the banking system liquidity is not unusual due to exchange rate fluctuation of RMB. Even if individual banks strapped for cash, that is the structure of a single bank liquidity is a problem, not the overall liquidity in the banking system caused by tension. Maintaining banking system liquidity "moderate" will help "keep the economy running at a reasonable range."

In the latter case, "RRR" (such as 0.5 percentage points), although the release of 515 billion yuan currency can (in January deposits 103 trillion yuan terms), but released mobility (according to five times the money multiplier calculated theoretically derived market liquidity will magnify 2.575 trillion yuan), where the flow is a problem. Currently, the downturn in the real economy, capital requirements are not strong, shouting money is either capital-intensive housing prices, either need to borrow new-old, dependent on credit alleys overcapacity enterprises, either infrastructure projects of local government investment . If the "RRR" release liquidity, eventually went to these places, the result is nothing more than house prices continue to rise, continued excess capacity, local government debt ratio continued to climb. This is not only conducive to China's economic restructuring, will run the risk of increasing Chinese economy.

From the current attitude of the monetary authorities of view, the monetary authorities on the one hand continue to increase open market operations, by 14 and 28 day repurchase operations, modest efforts to improve hedge deeper locked mobility; hand officially support the re-credit policy support the creation of a small loan category under refinancing designed to support financial institutions to expand credit small and micro enterprises, while supporting small and then issued a nationwide total of 50 billion yuan credit line. This combination of monetary policy operations, revealing what information?

It may be recalled in 2013 fourth quarter monetary policy report of such a statement: "The central bank will continue to implement prudent monetary policy, while in the background of the rapid development of financial innovation, regulation and guidance role of liquidity gate is more important to rational use of various tools combination of open market operations, reserve ratio, then loans, manage and regulate the banking system liquidity, stability is expected to promote the smooth operation of the market interest rates. "Here, although the central bank clearly lists the" open market operation, the deposit reserve ratio, re-lending, "the three tools of monetary policy, but in order to better play" control gate and the guiding role of liquidity, "the central bank is still the most frequently used is more flexibility, accuracy of publicly market operations, complemented refinancing and other monetary policy tools alone "RRR" tool did not use.

Why not to use the "RRR" tool?

On the one hand, the use of "RRR" tool will make the market began to loosen monetary policy misjudgment signal, which not only does not meet the "mobility gate control and guidance" target, does not conform to the government work report identified "Monetary policy should remain moderate tension, and promote basic balance between total supply community, and create a stable monetary and financial environment" policy orientation.

On the other hand, compared with the use of "RRR" tool, the monetary authorities now seems more inclined to "blending into the reform in the regulation." January 20 this year the central bank in Beijing, Jiangsu, Shandong, Guangdong, Hebei, Shanxi, Zhejiang, Jilin, Henan, Shenzhen, convenient to carry out the operation of pilot standing lending branches to meet the requirements of small and medium financial institutions to provide short-term liquidity by the central bank support, to March 21, the central bank in the credit policy to support the creation of supporting small refinancing refinancing category, the central bank has always attached great importance to monetary policy combined with the deepening of reform, the double combination through regulation and reform, the fluidity to be more precise delivery to make monetary policy operation means richer, so that the macro-control effect more pronounced, and more stable monetary and financial environment.

Currently, the Chinese economy's dependence on investment and debt rising, the potential risk of economic and financial areas of concern. In this context, continue to "RRR" will delay the deleveraging of financial institutions and corporate processes, the impact of China's economic structure was further optimized. For this reason, it is necessary to continue to adhere to the "total stability, structural optimization" policy orientation. But to adhere to the "total stability, structural optimization" policy orientation, we must make greater use of open market operations, refinancing and other tools to facilitate the standing lending portfolio is expected to strengthen the guidance, strengthen regulation of proactive, targeted, synergistic, overall steady growth, adjusting structure, promoting reform and anti-risk, continue to create a stable monetary and financial environment for structural adjustment and restructuring and upgrading. Unless the United States to reduce the size of the debt purchase, QE exit too fast, causing the total liquidity of the banking system changes, thereby enabling the micro-economy capital chain tension, increasing systemic risk, the risk of stalling the Chinese economy, otherwise the operation of monetary policy remains open market operations will continue to be dominated.

Political Battle Behind the Scenes Still Ongoing in China; Economic Reform Isn't Solely Economic Reform

The slowdown in China is not only an economic policy. As I've pointed out before in several posts, a political change is taking place under the guise of economic policy. The deflationary policies of the Xi-Li government will hit their political enemies. Deflation always reveals corruption that was hidden by rising profits. With an anti-corruption policy in place, the leadership is lining up its political enemies to fall.

One such enemy was Zhou Yongkang.

China seizes $14.5 billion assets from family, associates of ex-security chief: sources
The sheer size of the asset seizures and the scale of the investigations into the people around Zhou - both unreported until now - make the corruption probe unprecedented in modern China and would appear to show that President Xi Jinping is tackling graft at the highest levels.

But it may also be driven partly by political payback after Zhou angered leaders such as Xi by opposing the ouster of former high-flying politician Bo Xilai, who was jailed for life in September for corruption and abuse of power.
This is incorrect. He is not being punished for opposing Bo Xilai's removal, he is being punished because he was Bo Xilai's mentor. He was grooming Bo for a spot on the Politburo. Bo Xilai was trying to revive Maoism and was the head of a Red cultural push. This is the exact opposite of where the reform camp (liberals) want to go, and the pro-business Shanghai clique isn't interested in turning back the clock.

The reform camp started up financial reforms as soon as Bo Xilai was arrested. (See: Major financial reforms begin in China)

There's also the PBOC's indifference towards the pain felt by banks being hit with competition from online money markets offered by firms such as Alibaba. This is not at all surprising given the comments by Wen Jiabao only weeks after the arrest of Bo Xilai (see: Why is Wen Jiabao criticizing the banks?) I wrote:
Instead of prosecuting the booming gray market business, China has legalized it and after it succeeds, will spread it across the country. A private financial system will compete with state-owned banks for deposits. It will pay higher interest rates and charge higher rates for loans, to better credit risks, while the state-owned banks continue make bad loans to politically connected firms. Eventually, this will start impacting the state banks and instead of being regulated by politics, they will be regulated by markets. The old way to reform the banking sector was top down reform of the state-owned banks. This failed, the PBOC was blocked by the Ministry of Finance, and everything went back to business as usual after 2008. Now, a new reform effort is taking place, a bottom up approach that is more likely to succeed and far greater impact on the Chinese economy.

Those looking for a stimulus to boost the Chinese economy are looking in the wrong place. The economic slowdown is part of a much larger economic and political reform effort. This may not be the reform that Western observers want, but their criticism of China's political system has far less bite given the repeated failures in Egypt, Libya, Syria and now Ukraine. China is liberalizing in its own way, and the more economic pain that falls on the political opposition, the better. Remember that the party insiders used the state banks to enrich themselves and delay reforms post-2008, having already stopped reforms in 2005. (See: The Battle For China Continues On All Fronts) The state banks will not fail, but if they reach the point where they need a bailout, the reform minded PBOC will have enormous power to reshape the politically weakened banks.

The leadership doesn't want a runaway crisis, but economists who ignore the political dimension aren't seeing the whole picture. The current administration has much to gain politically from an economic slowdown.


Land Prices Cool in China

Price cuts of ¥2000 to ¥5000/sqm are typical across China. Only Beijing is below 10 months supply among first-tier cities, Shanghai, Shenzhen and Guangzhou are all over 10 months. Second-tier cities such as Wuhan, Tianjin and Xian have less than 20 months supply, while Beihai and Hangzhou are above 20 months supply.

This oversupply is hitting land sales (which account for the majority of local government revenue in many cases). Through March 25, there were only ¥8.45 billion in first-tier city land sales versus ¥32 billion at the same point in 2013. Developers aren't willing to pay big premiums to grab land with prices cooling.

楼市供应过剩风险加大 3月土地市场遇冷

Spreads Widen on WMPs

金牛 hasn't been updating their weekly trust data for the past couple of weeks, hopefully they will still put out the monthly report. Sometimes good data sets have a way of suddenly disappearing once the data turns sour, like the daily updated chart on steel that suddenly stopped being updated.

Here's the interest rate spread (blue) between WMPs offered at large (yellow) and small/medium (orange) banks.

Here's the same, for guaranteed (yellow) and non-guaranteed products.

Here's the spread between short-term (yellow) and long-term products.

Fear Driven Headlines

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Renminbi Depreciates 3%, Arbitrageurs Suffer Huge Losses

3% devaluation: hot money fled China to accelerate arbitrage losses
This year, facing an unprecedented devaluation of the RMB, the depreciation rate was close to 3%. Devaluation of the yuan, not only offset the 2013 full-year gains, but also a direct result of the appreciation of the RMB is expected to depreciate from the reversal.

Meanwhile, last March, RQFII-ETF funds also suffered a rare large-scale redemptions, many Hong Kong banks also raise RMB deposit interest rates in the near future, as well as other phenomena show, after being cut off arbitrage, hot money is accelerating flee.

RQFII-ETF suffered substantial redemption

RQFII fund is suffering from a rare large-scale redemptions. According to Wind data show that as of March 27, included in the statistics of 14 RQFII fund its redemption of up to 613,500,000, of which South A50 redemption is as high as 468.5 million shares were received, representing a net 3.9 billion yuan of funds outflows. In addition, Bo FA50, China CSI 300ETF [-0.87%], easy Fonda CSI 100ETF and other funds also suffered more substantial redemption.

Earlier in January, the statistics included 14 RQFII funds, net purchase of up to 229.4 million copies of the Units, including the South A50 is to get 192 million copies of I., the equivalent of 1.7 billion yuan capital inflows. However, this situation has quietly change occurred in February last year, although the magnitude of the South I. A50 still get some, but the overall trend reversal RQFII share preached redemption share of 9.87 million copies.

It is noteworthy that H-shares since March, down 0.18% Hang Seng China Enterprises Index, almost completed a small V-shaped recovery. At the same time, according to EPFR Global statistics show March 12 to March 19, China stock fund net capital outflows of more than $ 1.5 billion, the most since January 2008 biggest weekly net outflow on record. Among them, investors in China's stock-based funds have redemption amount hitting record statistics since.

Hong Kong's fund industry have pointed out that since March RQFII-ETF redemption, H shares fell and so did not see consistent data, although a portion of the hot money reflects weak data out of China's concerns, but in fact it is due to the devaluation , resulting in lack of arbitrage, promote accelerated hot money fled the facts appear.

RMB arbitrage losses

This year, facing an unprecedented devaluation of the RMB, and its magnitude was close to 3%. Spot exchange rate of RMB against the U.S. dollar from the market point of view, January 14 closing price of 6.0406 yuan, to yesterday's closing price of 6.2103 yuan, down 2.85 percent. Devaluation of the yuan, not only offset the 2013 full-year gains, but also a direct result of the appreciation of the RMB is expected to depreciate from the reversal.

BOCI commented that the yuan-dollar exchange rate has been significantly devalued since the beginning of this year, about 3%, the larger the depreciation rate, the inertia of the current market expectations of RMB appreciation has been broken, replaced by a look of RMB empty sound, In this case, the central bank has no further guidance exchange rate depreciation. If the above analysis is correct, then the next time the RMB exchange rate depreciation may slow or even stop the pace, which could again surprise exchange speculators expected.

According to the Bank for International Settlements (BIS) statistics show that Hong Kong is the total loans granted to foreign banks mainland has reached 430 billion U.S. dollars, Hong Kong banks on the mainland net debt to total debt close to 40%. With the demand for such loans usually increase the appreciation of the yuan, will be reduced when the decline in value of the renminbi.

Expected changes in the RMB arbitrageurs, is undoubtedly a blow, the Hong Kong banking sector pointed out that "a substantial devaluation of the RMB appreciation of the renminbi will bet arbitrage devastating blow. Many investors borrowing by banks in Hong Kong before you buy renminbi assets related to arbitrage RQFII etc. If in accordance with the magnitude of devaluation since the beginning of this year, investors lost arbitrage trading up $ 14 billion. "[page]

RMB arbitrage Currently, there are four: poor onshore offshore spot exchange arbitrage, NDF and DF poor exchange arbitrage, savings and loan spreads onshore offshore arbitrage, cross-currency arbitrage spreads. Moneta is a research report pointed out that the appreciation of the RMB channel, spreads and exchange differences will bring double harvest. Specifically, companies in the territory of A "deposit" and asked after issuing letters of credit to the offshore partner B, B obtained in accordance with the offshore rate corresponding amount of foreign currency loans and foreign currency payments by the sum of imported goods to the A to A; A In the onshore foreign exchange rates for the yuan. After expiration, A to obtain domestic RMB "deposit" principal and interest, and in accordance with the maturity rate of conversion of foreign currency loans to pay principal and interest and.

Grabbing Gangyin Tilly rate of RMB deposits

It is worth noting that, due to the appreciation of the renminbi is expected to be reversed, Hong Kong's offshore RMB deposits are subtle changes. Some customers based on the expected appreciation of the renminbi is already in panic selling among the renminbi. In order to deal with this situation, many Hong Kong banks to raise interest rates start dishing out tricks.

If ICBC (Asia) recently announced by March 14 until April 30 this year, the introduction of a phased incremental RMB deposit interest rate concessions, the highest annual interest rate of 4%, the highest in Hong Kong temporarily, deposit amount of 100,000 yuan, all for an average of 3.3%. CCB Asia recently introduced incentives RMB deposit interest also 3.4%. The offer is subject to the new capital 金开立, in three stages, the first stage is open from the date of deposit of 2.5% in the first 90 days, the second stage of the deposit of the first 91 to 180 days, the deposit interest rate of 3.3% in the third stage by the deposit of 181 days to 288 days, interest rate 4%.

Standard Chartered Hong Kong has also recently announced that on March 21 until the end of April, the new capital of 20,000 yuan deposit, the contractor six-month fixed deposit interest rate of 3.2% per annum and maturity interest income of $ 320 applies only to new customers, that is, did not have to hold any bank product or service in the line in the last 12 months, except for credit cards. Standard Chartered Hong Kong, Greater China, deposit and mortgage business executives Wangwei Xian and said the introduction of short-term promotions aimed hope to attract more yuan, either high or general customers, the RMB deposit interest rates seem high is an effective way to attract new customers.

In addition, DBS Bank (Hong Kong) has announced an increase of RMB fixed-rate deposit rate from 2.8% to 3%. At present, Hong Kong renminbi business bankers still maintain a high confidence. Head of Global Markets, Standard Chartered Hong Kong Ming Qiao said that last year the external atmosphere of uncertainty, the U.S. QE delisting make global markets more volatile in the second half, but also double-digit growth in RMB business, the first two months of this year also good to keep this momentum, confidence double-digit growth this year also.

Devaluation suppress the financing needs of commerce

Since January 2014, the spot exchange rate of RMB devaluation of more than 2%. In this round of devaluation in the commodity markets also fluctuate significantly, which is the market dubbed "Dr. Copper" metallic copper financing needs first name is suppressed, causing panic copper fell, the cumulative drop of more than 12% since the beginning.

Analysts pointed out that devaluation leads to arbitrage commodity trade finance is compressed, such as copper, rubber and other industrial products "financial premium" slowly flowing, some traders close out their positions as soon as possible, the original did not enter the supply and demand side of the real goods market increased social pressure on the stock price in the short term remains to be suppressed.

Devaluation triggered selling of goods

After February, devaluation trend seems to be accelerating. Insiders said that following week, one yuan of 0.58 percent recorded the largest increase in two years, on March 25 and 26, the spot rate continued to weaken, showing at least the short term devaluation trend is not easy to reverse.

In this context, the commodity can be spared? Obviously, for a long time, financing imports of commodities slump lay hidden. As domestic interest rates continue to rise, the bank credit limit for steel and other industries, many companies take to borrow low-interest dollars and imports of iron ore, copper and other commodities to finance, can enjoy the benefits of unilateral RMB appreciation and interest rate, which leads to iron ore , copper and other imported goods stocks continued to rise.

Insiders said that the devaluation induced selling, financing collateral as iron ore and copper, face the risk of margin calls and forced the bank realized, and therefore the first to enter the iron ore and copper plummeted. As of March 27, even the iron ore and copper futures contract in March were the cumulative drop of more than 7%. [Page]

Fu Bao Lei Lianhua metals analyst, said copper process at a later stage financing, you need to use the RMB to buy dollars to return the money, devaluation would mean the need for more yuan to buy dollars, but not like before can enjoy RMB appreciation as the profit. And during yuan fell, investment bank raised the proportion of financing copper deposit payment, advance in finance copper arbitrage settled on copper prices played a role in fueling.

Nanhua Futures in an analysis report that the slump may lead ore mill capital chain crisis. Currently more than 100 million tons of imported iron ore port, most mills' financing mine. " And all have taken the margin financing business operations with financial leverage, iron ore continuous fall, steel heavy losses, but also forced margin calls, exacerbating the financial strain.

Unfavorable commodity imports

With domestic funds face tight, more and more goods with a stronger financial attributes, which now includes iron ore, soybeans, palm oil, rubber, zinc, aluminum, gold, copper, and nickel, which also makes include copper contains a variety of commodities within the "Financial premium" in the price, because the market for the financing of the Chinese commodity imports as the demand, which led to a rise in commodity prices.

Assistant Director of Finance Cheng Xiaoyong Baocheng Futures Institute, said devaluation impact on commodity markets can be analyzed from three aspects: First, the RMB devaluation will lead to lower purchasing power, is not conducive to commodity imports. Commodities such as copper and iron ore imports will be inhibited, leading to China's apparent consumption of goods declined, imports of raw materials prices; Second, the devaluation will lead to decline in the trade surplus, foreign exchange reduced compression of the renminbi liquidity, thus driving up the cost of corporate financing, making downstream replenishment will decline, increasing the opportunity cost of holding commodities. Third, the devaluation led to arbitrage trading commodities financing narrow because of the devaluation of RMB will lead to reversal of spot and forward exchange differences, increasing the cost to hedge exchange rate fluctuations, which devaluation is bad for consumer goods and for goods out of the library In a way favorable.

However, some industry insiders believe that the current devaluation so do trade financing businesses pay more attention to interest rate risk control under poor conditions favorable financing trade will continue to exist.

Long-term strength of a solid material foundation RMB

Newspaper reporter Wang Hui

For the beginning of the current round of RMB accelerated since February Zoubian mainstream institutional analysis view generally believe that macroeconomic fundamentals since 2014, starting the year, especially the weak performance of the import and export sector is the main cause of the RMB exchange rate continued to plunge . At the same time, the RMB exchange rate volatility overlay expanding the scale of the Fed's QE sustained cuts and other factors, the RMB exchange rate declines further amplification occurs to some extent. But on the other hand, integrated international payments, labor productivity and other long-term factors, the basic long-term appreciation of the RMB is still relatively strong.

Fundamentals clouds caused yuan plunge

For this round of the RMB exchange rate continued to weaken the underlying factors behind the current market mainstream generally be attributed to economic fundamentals, "not to force", especially the monthly trade deficit in February and hot money outflow has just appeared.

Haitong Securities , said in February trade has a huge deficit of $ 23 billion, reflecting the outflow of hot money is the real reason for exchange rate depreciation in February. In falling interest rates, the deficit appears in the background, does not exclude the RMB exchange rate weakness become a trend for some time. Guotai Junan also believes that in January, foreign exchange and foreign exchange settlement bank as reflected in the high growth of large-scale inflows of hot money has become in the past, is expected in February has been the outflow of hot money, March outflow will face greater pressure. In this context, the RMB is facing the reality Zoubian pressure gradually phased devaluation expectations or enhanced. Guoxin Securities (Hong Kong) is the latest view is further believed that the early performance of the RMB exchange rate weakness can be understood as the central bank initiative to guide devaluation of the Renminbi yuan to expand bilateral trading range. But on the other hand, due to the unilateral change in the expected appreciation of the adverse effects of a substantial trade deficit superimposed expected the recent devaluation pressures.

On the other hand, combining the latest in a Fed rate decision, Founder Securities number of agencies, Haitong and securities that the Fed rate hike earlier point in time, to further improve in the second quarter U.S. economic data that may occur, are likely to become the next dollar support force. In this context, the weak dollar may come to an end early. If the dollar began to enter the strong, the current round of devaluation pressure and persistence may exceed market expectations, does not exclude the RMB spot rate will depreciate to around 6.30 level.

Long-term basis the RMB exchange rate still strong

Despite short-term market parties for the RMB exchange rate is expected to depreciate further doctrinal, but in terms of long-term trend of the RMB exchange rate, most organizations still believe that viewpoint, the basis of long-term appreciation of the RMB is still relatively strong.

United States Securities pointed out that the overall balance of payments remain high and labor productivity, there is room for improvement in the future, the yuan will continue to appreciate the long-term cycle as the main feature. Analyze perspectives from BOC believes that although short-term deterioration in trading conditions and prompted the central bank to guide exchange rate devaluation, however, due to the long-term China will hold the balance of payments surplus has not changed, in order to determine the long-term renminbi foreign exchange supply and demand will be based continue to slowly appreciate. [Page]

For the full year 2014, the RMB exchange rate performance, GF Securities believes that although foreign exchange added in February than expected, but in fact, financial institutions, foreign exchange settlement this month "flow indicators" is not bad. In the case of long-term appreciation of the yuan-based and does not melt, for this year the RMB exchange rate and foreign exchange need not be too pessimistic about the overall situation.

In addition, from the Agricultural Bank of Strategic Planning Department analysis that, given the appreciation of the RMB is not conducive to the stability of unilateral export, has accumulated a large renminbi devaluation of early pressure, China's trade surplus with the United States remain a number of factors such as higher levels of recent devaluation of the RMB exchange rate is not the start of RMB devaluation, but indicates that the RMB exchange rate will return to two-way volatility trend. From 2014 full-year trend, this trend is expected to reproduce the 2012 RMB trend, namely the central parity, the real effective exchange rate will continue to rise slightly throughout the year, while the annual growth of foreign exchange, the overall pressure of hot money inflows remain relatively low.

In addition, from Hong Yuan Securities viewpoints agencies pointed out that in the RMB exchange rate "excess volatility", the monetary authorities will still be flexible intervention to prevent unilateral RMB appreciation or depreciation of unilateral excessive volatility, the current judgment of RMB long walk derogatory apparently premature.

Ye Lunjia interest position is expected to support strong dollar pattern

Although in the last few trading days, the dollar index showing a high pullback rally after hovering around the 80 mark integer. But in the last week, Fed Chairman 席耶伦 first press conference on the future rate hikes took the time to make a statement after, and the after market earlier than expected, the dollar has become a high probability event. Especially relative to other major economies to further easing, the Fed will tighten monetary policy but, given the dollar strong support.

European version of QE or hurt the euro

Many senior European Central Bank recently released a strong liberal continuous signal that the bank was ready to consider the introduction of a "major initiative" to combat low inflation risks, including negative interest rates and quantitative easing (QE) measures. Industry insiders estimate that the European Central Bank launched in April, "the European version of QE" significant increase in the probability, and the euro-dollar exchange rate will be significantly under pressure.

Next ECB meeting will be held on April 3, at its meeting in March, the European Central Bank unexpectedly took no further action, the market disappointed. Eurozone inflation in February this year, a revised annual rate of 0.7%, was the lowest since October 2013 level, further away from "less than, but close to 2%" of the target.

QE was one of the main opponents of the German Bundesbank President Weidmann recently said that the ECB's monetary policy is being discussed core issues - the effectiveness of quantitative easing, and determine whether the benefits outweigh the costs and side effects. If the inflation outlook changes, such as the euro appreciation, the ECB may intervene or cut interest rates again, and may even launch quantitative easing. In addition to opposition to QE, the ECB Weidmann is also a member of the Council of the only direct monetary transactions (OMT) program of opposition, change their attitude opens the door to quantitative easing.

Liikanen, Finland's central bank governor, said recently that the ECB still has interest rate adjustment. When asked whether the European Central Bank to buy government bonds in violation of the EU Treaty, Liikanen pointed out that "this is not a legal issue. Treaties allowed to buy from the secondary market."

Slovak central bank governor Maku He disclosed that several ECB policymakers have been prepared to take extraordinary measures to prevent the euro zone into a deflationary environment. "And that is a choice of quantitative easing ECB." European Central Bank President Mario Draghi will once again stressed that the ECB will take the necessary measures to maintain price stability, the bank are closely watching the euro exchange rate.

ECB's benchmark interest rate is currently 0.25 percent, analysts believe that although the rates have hit historic lows, but in the euro area inflation rate is still low in the background, the traditional monetary policy instruments such as interest rate cuts in the space is very limited.

Yen carry unwinding cool

Japan's accounting system requirements for settlement after settlement must be replaced yen of Japanese companies, Japanese companies in order to cope with the year end, had detached from overseas high-yield bond market out, and then replaced repatriate yen surplus in the balance sheet included in the annual After these preliminary use of the yen carry trade unwinding reflux lot of money constitutes a large Japanese yen essence buying, pushing the yen rising.

So according to common sense, basically from the beginning of February it will generate money back phenomenon. Statistics show that, after three years, the exchange rate of the U.S. dollar against the yen are weak trend in March. But this situation, the yen carry trade unwinding significant cooling, which has not scheduled a stronger exchange rate. USDJPY continued to rise since the beginning of March 18th, from the 17th closing price of 101.44 rose 27 closing price of 102.22.

Mainly due to the strong yen has not traditionally phased sectors is expected to further drain the central bank will soon. From April 1, the Japanese consumption tax rate raised from the current 5% 8% of the policy will take effect, raising the consumption tax to ease the financial burden of Japan can indeed bring "immediate" effect, subsidize certain fiscal gap quickly in the short term, but but then inhibit consumption constitutes the ultimate level of inflation in Japan, "standard", the overall mood of economic growth, as well as the financial markets will be a blow, introduced in April last year, the central bank quantitative easing monetary policy effects will also be greatly reduced.

The Bank of Japan has recently made it clear that this initiative will raise taxes temporarily lead to the country's economy into 4-6 month of negative growth. Japan Center for Economic Research recently authoritative survey results 40 economists showed that 90 percent of economists expect the Bank of Japan will take new measures this year, which the bank is expected to take measures in July proportion of economists maximum, and since April 2013 launch massive easing, the Bank of Japan has not yet taken over more policy action.

Goldman Sachs Group's latest research report predicts the central bank will set off a new round of "easing cycle" in May this year, the yen will continue to fall. Nomura Securities pointed out that Japan's economic growth for the fourth quarter of last year grew at an annual rate of 1%, far below market expectations of growth of 2.8%, highlighting the risks of its recovery is weak, and in April the Japanese consumption tax hike will bring greater pressure, it is important data is poor or procure the Bank of Japan will soon further increase monetary easing efforts. Mitsubishi Tokyo UFJ Bank Hull, research director Rafael, said the Bank of Japan is likely to be forced to further "act" in the near future, while the U.S. dollar against the yen's gains will be consolidated.

Chinese Corporate Investors in the Dark as Trust Investments Falter; Borrow Short to Lend Long Strategy Falling Apart in 2014

One company at the center of a liquidating trust is HIT Shougang Technology (translated by Google as Workers first), which according to Bloomberg:
HIT Shouchuang Technology Co., Ltd. owns and operates a chain of department stores that sell a general line of apparel, electric appliances, home furnishings, and other miscellaneous general merchandise. Through its subsidiaries, the Company also develops computer software and provides tourism and food services.

The firm was having weak earnings and found they could earn more money by investing in trust products. These were pooled products used to fund other trust investments about which the investor knows next to nothing. On top of that, the fund company borrows short and lends long, rolling over the pooled trusts at lower interest to invest in higher return products. When trust fundraising collapses as it has in 2014, the firms borrowing short to lend long are forced into liquidation in order to return capital to investors.

Long story short: China's trust problems have a much wider reach than most media coverage lets on. Even listed companies with seemingly no relation to the industry are at risk due to firm capital being tied up in these products.

Below is the Google Translation of the story. 中航信托兑付延期:工大首创深陷“资金池”
21st Century Network ( microblogging ) listed company "job" is not a new topic, remove or PE real estate projects, trust management is also likely to allow listed companies planted a somersault.

Workers first before the announcement, saying the purchase of 10 million "Tin Fu • Aviation Trust Capital Trust Scheme No. 26," with an original maturity of March 19 this year, failed to timely payment.

Reporters call the workers first, that the company is negotiating with AVIC Trust, has not received a clear answer. The Aviation Trust insiders said the product is being liquidated, the two sides argued for their own, it seems a novelty.

Trust products into the unknown

In recent years, as many trust funds pool model of product innovation direction, that when the issue of trust products to investors to establish a "pool of funds" to raise funds after the first, and then by the trust funds to invest in its sole discretion. This model, while improving the utilization of funds also increased the potential risks of the product.

Workers first on March 26 issued a statement saying, Central Air Trust initiated and established "Aviation Trust • Tianfu the 26th Capital Trust scheme," the original maturity date of March 19, 2014, according to the trust document conventions, trust is automatically postponed to allow all-cash assets so far. As of the announcement date, due to the emergence of China Aviation trusts the maturity can not be cashed in, causing the company is currently unable to recover the principal and the corresponding revenue, the company will actively contact the Aviation Trust verify the situation.

The Trust plans to AVIC Trust Corporation in March 19, 2013 launch, the total fund size of 11 million yuan, the expected annual yield of 7.5%, subject to the issue of individual and institutional investors, one-year period, the investment threshold is 800,000 yuan, the China CITIC Bank Corporation Limited Nanchang Branch hosted a collection of funds belonging to the trust.

Trust documents show that its investment direction:

Trust Trust Units or beneficiary under the trust scheme under the Trust Scheme (1) capital investment trust under the Trust Scheme good reputation in the industry trust company (including the Trustee I) issued investment targets in line with one of the following conditions :

① all kinds of infrastructure projects; ② quality corporate liquidity loan program; ③ pledge of shares of listed companies financing the project; ④ energy development and financing projects; ⑤ securities investment projects; ⑥ other projects approved by the Trustee;

(2) under the Trust Scheme trust funds to invest in the trust property under a trust scheme a good reputation in the industry trust issue.

(3) under the Trust Scheme trust funds to invest in financial institutions, along with the management of the Trustee considers low-risk, highly liquid fixed income assets.

Trust funds idle period (4) the existence of a trust can be used to store commercial banks, investment in the inter-bank bond market, money market funds and the trustees believe the same time with low-risk, high liquidity of other financial products.

The above documents show the direction of investment suggests that such products are not actually clear investment targets, a "pool of funds" products. These products are characterized in the trust funds to invest in the contract is not clear, but framed the direction of investment, such as debt, equity, other trusts, flexible product term, there are 3 months, 6 months, 9 months, 1 year, 2 years.

"Trust in the aircraft prior to the announcement show normal results in the aircraft product maturity extension bulletin released, and we are to understand the situation, it is unclear specific issues." Workers first insiders said the network of the 21st century.

Aviation Trust, formerly known as Jiangxi Jiangnan Trust Corp., the China Aviation Industry Group Co., Ltd., China Aviation Technology Shenzhen Co., Ltd. and the introduction of strategic investors such as Singapore's OCBC Bank initiated the formation of five units.

Until Aviation Trust March 19 announcement said, "Aviation Trust • Tianfu the 26th Capital Trust scheme," an original maturity of March 19, 2014, according to the trust document conventions, trust is automatically extended to allow all cash assets .

The report of the trust fund management plan shows, July 1, 2013 to September 30, 2013, trust income of $ 133,962.21, Trust expenses 133.30 yuan; October 1, 2013 to December 31, 2013, trust income 78.54 Yuan, trustee fee $ 0, in the meantime, the executive manager of the Trust by the 杨海晨 changed to Liu Zhipeng.

21st Century Network Contact Zhipeng, no one answered the phone has been in the state. The Aviation Trust office personnel said that the product is still clearing them. Obviously workers first statement contradictory aspects.

Earnings growth has become a financial investment

Workers first 2013 report shows that the company's main business is subject to the impact of the retail network suffered ceiling, financial investment has become a new profit growth point initiative is trying to work great pioneering.

Report shows that workers first in 2013 net profit attributable to equity holders of 3,569.78 million, a decrease over the previous year 1,201,400 yuan, a decrease of 3.26%. Net profit after deducting non-recurring gains and losses attributable to equity holders of 3,493.82 million, a decrease over the previous year 1,211,400 yuan, a decrease of 3.35 percent. ; Earnings per share of 0.159 yuan, 0.005 yuan decrease over the previous year, a decrease of 3.05%.

The direction of foreign investment last year, workers first on the stock of capital investment is 30 million yuan, representing an increase of 20 million yuan a year earlier, to obtain investment income 757,600 yuan, the operation failed to achieve the target set at the beginning of last year.

Workers first purchase financial products last year, a total 90 million yuan, 50 million yuan, including trust banking, and bank financing 40 million yuan (duration 106 days), the bank's financial products were recovered in April and principal investment income 47.63 million.

Workers first purchase of 50 million yuan for the trust financial products, including: poly Berry Gold collection of funds 40 million yuan on the 20th and AVIC Trust • Tianfu the 26th set of capital of 10 million yuan, accounting for 7.6% of the company's net assets and 1.9% .

Bry-poly gold on the 20th Capital Trust scheme initiated by the Bridge Trust, the duration of one year, the scale of 40 million yuan Shifa expected annualized rate of return of 7%, the termination date is May 14 of this year, non-TOT products, including but not limited funding to invest in loans, equity, limited partnerships, investments and other financial products by way of portfolio investment.

According to the SFC guidelines require listed companies to use idle raising investment products must meet safety, meet the requirements of security, product issuers to provide the promised security and other conditions.

Or have a greater risk of incident

Aviation Trust • Rich on the 26th day itself is not large, or belong to a female child below Trust Trust.

Was supposed to expire March 19, 2014 • Aviation Trust Tianfu the 26th Capital Trust scheme, which belongs to the Aviation Trust Tianfu products. 21st Century Network two channels of data obtained from the point of view, "Fu on the 26th day" to raise the scale of less than 20 million yuan. Workers first subscribed for 10 million yuan, accounting for the bulk of the whole should trust scheme.

The 21st Century Network access AVIC's Tianfu products found belong to TOT (Trust Trust), that the child trusts to raise a certain amount of money and then invest in the parent trust, the trust is deemed to institutional investors in the sub-parent trust. This approach reduces the investment threshold, but opaque to raise funds to invest, investors are difficult to grasp the direction of the use of funds, there is no way to confirm the risk level of trust products.

Product data show that "the rich on the 26th day" itself is a rich series of TOT trusts next day, plus small-scale raising, most likely also belong to a female child below Trust Trust.

It works great first expressed in terms of respect: "Trust in the aircraft due to the emergence of the maturity terms can not deal with, resulting in the company is currently unable to recover the principal and the corresponding revenue."

If the "Tianfu the 26th" TOT really belongs to the sub-trust, but workers first principal repayment terms can not really trust products to invest in because there is a problem, then the event this AVIC Trust faced, or more than "the rich on the 26th day "A trust products so simple, but a large-scale" mother trusts' principal aspects of the emergence of risk can not be recovered.

21st Century Network Contact parties trust manager Liu Zhipeng, no one answered the phone has been in a state. On the other hand, the Air Trust, said aspects of the 21st Century Network, this product is now being liquidated, still walking the corresponding processes, will be distributed within 10 working days. The above statement saying the workers first aspect of the conflict.

The truth of how, in the 21st century network will keep a close eye.

To remind the industry in attracting high expected return, the increasing number of listed companies choose to earn extra income trust products outside the main income, but the listed company does not have sufficient expertise to determine whether they have the solvency of the investment project For trust product safety should be given greater attention.

Pu Yi Fan Jie wealth researcher said on 21st Century Network, the listed investment trust company products is a strange thing. Investment bank financing as well as the purpose of maintaining a good relationship with the bank, but trust listed companies give what value? If the listed company through a trust to finance its financing costs much higher than the benefit, listed companies generally do not need to say through the Trust to finance investment trust listed companies are not optimistic.

Features of the pool of funds is longer borrow short, in addition to general investment credit risk, the biggest risk is liquidity pools of capital goods. If the child failed to honor the trust, the trust may be a risk of the mother, there may be a liquidity problem in the

China to Effectively Shut Bitcoin Exchanges; Price Down 16% Hours After News Circulate

What China buys goes up in price. What China sells goes down in price. This regulation will force sales. Volume for the day at BTC China is up 25% in the past hour (20% of the daily volume up until now occurred in the past hour) and it is late in the evening in China.

From Caixin:
PBOC Rule Means Bitcoin Websites in China Must Close, Expert Says
The central bank has taken a step that at least one expert says means all bitcoin trading websites in the country must close.

The People's Bank of China (PBOC) renewed its crackdown on bitcoins by requiring banks and payment companies to close all the accounts opened by the operators of websites that trade in the virtual currency by April 15.

This means people will only be able to use cash to buy bitcoins, an analyst who has been following the matter said, and will force all trading websites in the country to close.

"The only one way out for bitcoin websites is moving their servers abroad and using the service of foreign banks and payment companies," the expert said.

The requirement, which Caixin saw in a document the central bank's headquarters recently sent to regional offices, says money can be taken from the accounts before the deadline, but no deposits can be made. Banks that fail to close the accounts will be punished, the PBOC said, but it did not elaborate on what those punishments would be.

The central bank document listed 15 trading websites whose accounts must be closed.

From Bloomberg:
PBOC Orders Banks to Shut Bitcoin Exchange Accounts, Caixin Says
“I’m aware of the rumors circulating on the topic,” Bobby Lee, chief executive officer of BTC China, one of the largest Bitcoin exchanges in the Asian nation, said by phone today. “I haven’t heard of anything else to confirm that. We are still waiting to see what happens.”

The restrictions would be the latest on the virtual currency from the Chinese monetary authority, which has sought to limit dealings in the software currency that may be used to launder money or evade capital controls. The central bank issued a notice on Dec. 5 barring financial institutions and payment companies from buying and selling Bitcoin or dealing in linked products.

The central bank didn’t respond to a faxed inquiry about today’s report. In a March 21 statement on its microblog, the PBOC denied unspecified media reports that it had banned Bitcoin trading.

China First Tier Home Prices Start to Shake

One of the optimistic soft landing scenarios tossed around is that home price troubles are concentrated in third- and fourth-tier cities. First tier cities such as Beijing, Shanghai and Shenzhen won't see a big drop due to continued demand. If that scenario played out, it indeed could be called a soft landing, but unfortunately there are already some rumblings in the first-tier cities.

As the article below states in the headline, the changes are subtle and thus not yet a trend, but this bears close watching because if first-tier cities experience a drop in prices, it is 2008 all over again. An important part is the psychological aspect: first-tier cities are considered a refuge, the blue chips of Chinese real estate market. If prices drop there, it will be a major psychological blow to investors and also the general public. At the moment, the developers are blaming the price reductions on government policies aimed at lowering home prices. The key here will be the same as elsewhere: demand. Lower prices in the face of strong demand will attract more buyers into the market; weak demand will cause these large price cuts to put greater pressure on the market in coming weeks.

媒体称一线城市房价安全岛塌陷 正出现微妙变化
First-tier cities, "refuges" collapse

Property was considered "safe haven" in first-tier cities, emerging subtle changes.

Last week, located in Beijing Daxing, Beijing Vanke [ Introduction News ] Orange project low-cost market, the average price is only 21,000 / square meter, while the market had expected that the project is priced at 25,000 -26,000 yuan / square meter. Company general manager of Vanke Beijing Mao Daqing clarify that this is not the developer initiative to cut prices, but with the result of the government's regional policy limit.

In Shenzhen, there are developers who told reporters, located off the inside of a large redevelopment project for the year would have residential apartments products into the market, the developers intend Price 60,000 / square meter, but the government price of 40,000 yuan / square meter. Partial several other high-end projects also experienced similar problems.

"The so-called classification regulation, not like before more market-oriented understanding, in fact, the Chief of colors thicker." Analysis of the developers, said the purchase limit, the pre-sale permit issuance, capital supervision of these policies, how the combination with How much effort are local final say, in fact, strengthen the regulation means more places.

Chairman Cao small mountain rivers and mountains Capital believes that the current real estate market differentiation, different regions and between cities is very serious. However, the regulation does not mean exit administrative classification of policy instruments, which may be more severe, because the local government to control the high prices of land and access to income from both.

In the above context, Beijing, Shenzhen, Guangzhou recent market launch of the project almost are cheap. Centaline Research Department statistics show that Beijing has a total of 38 projects will enter the market in April, most of which are low-end commodity housing. These projects increase in basic controls 5% -10%, which is frequently the same period last year rose by 20% -30% of the price is quite different.

In Guangzhou and Shenzhen, March and April are basically new projects to affordable shipping, Guangzhou, and even a few items and pay the down payment scenario developers. "Dismal turnover during the Spring Festival, many projects did not dare to March opening, the situation is more delay," Shenzhen, a correspondent who said that last year the Shenzhen property market is ahead of overdraft, this new supply volume is large, it is difficult to support housing prices.

Central China Real Estate Research Center statistics show that as of 23, March 54 cities total housing signing 148,500 units, down 36% compared to the same period in 2013. Decline in first-tier cities which reached 45.8%, a decline of 48.2% in the second-tier.

Centaline chief analyst Zhang Dawei noted the need for housing sales prices on the second-tier market may lead to a more significant amount of running. As before, 30 housing prices announced before the February sales results, the single room rate 30 February sales total 66.5 billion. Ring cut 39 percent in January of 108.288 billion. The national housing climate index also fell again, down to 96.91, compared with last December fell 0.30 points.

Compared to small and medium-tier cities housing prices get together, most of the companies are listed on the first tier cities housing prices, higher demands on performance, but once sold, the stock slump may occur. The existence of these factors led to a change in first-tier cities may surprise market expectations. 21st Century Business Herald reporter to incomplete statistics, at present known to occur price adjustment cities including Beijing, Guangzhou, Hangzhou and Nanjing.

"It was thought that the regression line will be safe, but the present situation is not the case." A radical turn the wheel in the past two years, a second-tier developers who laments sales to the first-tier cities big problem, but it is difficult to guarantee profit margins, For a Hong Kong-listed developers, gross margin and net profit margin is more important.

Last year won a number of high-priced land in Beijing Agricultural Exhibition Hall, including the king of financial innovation in China [ Introduction News ] Chairman Sun Hongbin, results of the meeting in 2013 even worried the project will Nongzhanguan pricing 150,000 yuan / square m can not pass approval.

Has been concentrated in a second-tier cities, known for its high gross profit developers in Guangzhou KWG [ Introduction News ] executives also said the company does not rule out individual projects will be conducted in an appropriate promotional basis to maintain a 15% net profit margin on. China Co-President Dingzu Yu Yi Ju pointed out that from the overall trend, the profit level of housing prices will decline further.

Wu Zhihui, director of LaSalle Bank study warned that the impact of policy levers banks have tightened real estate sales terminals have begun to appear, the end of the current real estate market is in a small period of prosperity, growth in turnover in 2014 will fall to single digits. In this context, robust enough to finance the full security of small developers need to avoid solvency crisis.


Banks Hit Back At Alibaba

Alipay denies ICBC’s quick transfer accusation
Alipay, Alibaba Group's third-party online payment service provider, refuted Tuesday an accusation from Industrial and Commercial Bank of -China (ICBC) that Alipay's quick transfer service is "illegal."

ICBC said it lowered the upper limit of Alipay's quick transfer service in accordance with a regulation released by China Banking Regulatory Commission (CBRC) in 2011, the 21st Century Business Herald newspaper reported Tuesday.

Later on the same day, ICBC announced that it has closed service interfaces between Alipay's quick transfer service and ICBC's branches except one with ICBC's provincial branch in East China's Zhejiang Pro-vince, news portal sina.com reported Tuesday.

ICBC said the interface reduction is to avoid potential management risks and it has no impact on quick transfer "if Alipay cooperates with ICBC," according to the report.

But an independent analyst of online payment who declined to be named told the Global Times Tuesday that the reduction means new users outside Zhejiang Province cannot link new bank cards to Alipay's quick transfer service.

China's ICBC clamps down on Alibaba finance arm
Industrial and Commercial Bank of China Ltd (ICBC) will restrict trade with Alibaba's online payment arm to one branch, the bank said on Tuesday, in the country's latest crackdown on a nascent online finance industry.

Alibaba Group Holding Ltd's payment arm, Alipay, previously had contracts with numerous branches of ICBC for negotiated corporate deposits, and could place deposits with the branch offering the highest yield.

Tuesday's move means ICBC branches will no longer compete to offer high yields on Alipay's deposits, hitting the online payment business's revenues from interest, and potentially setting a precedent for other banks to follow.

The clash between entrenched interests in China's traditional finance sector and its internet companies has escalated in recent weeks, with banks imposing limits on how much their customers can transfer to online finance services and the authorities looking into potentially heavy regulation.

.......Banks, including ICBC, Bank of China Ltd, Agricultural Bank of China Ltd and China Construction Bank Corp, have restricted how much their customers can spend on Alibaba's and Tencent's online payment services.

Wealth management products, offered by Alipay, Tencent and Baidu Inc, can offer almost double the interest rate that China's traditional banks give depositors.


Real Estate Rage in Wuxi

Prices fell ¥2,000/sqm and recent buyers are upset, asking for the return of their hard earned money. The news says there was also some damage to the sales office.

无锡一楼盘降价2000元/㎡遭砸 新一波降价潮逼近?

Small Bank Run in China

Fear remains elevated. The bank in question was the subject of rumors, not any real information (though some may come to light in the coming days).

This is the downside to controlling information and always putting out the good news. When people become fearful in China, they do not trust the media or government. Rumors spread like wildfire.

Collapse rumours spark panic and run on small Chinese bank
Hundreds of people rushed on Tuesday to withdraw money from branches of two small Chinese banks after rumours spread about solvency at one of them, reflecting growing anxiety among investors as regulators signal greater tolerance for credit defaults.

The case highlights the urgency of plans to put in place a deposit insurance system to protect investors against bank insolvency, as Chinese grow increasingly nervous about the impact of slowing economic growth on financial institutions.

Regulators have said they will roll out deposit insurance as soon as possible, without giving a firm deadline.

Domestic media reported, and a local official confirmed, that ordinary depositors swarmed a branch of Jiangsu Sheyang Rural Commercial Bank in Yancheng in economically troubled Jiangsu province on Monday.


Guangdong Developer Sells Homes for 10% Down

This won't fly system wide because the government will not ease credit restrictions.


More Pro-Internet Banking Comments From Chinese Official

Former PBOC deputy governor Wu Xiaoling made the news last month when she said the government should allow trust products to fail. She's back in the news today with comments on Yu E Bao, stating that banks have no one to blame for Yu E Bao's success except themselves. She called for regulation, but also the encouragement of online banking innovation.

吴晓灵:余额宝高息是商业银行自己给的 怪不得别人
Phoenix Financial News "China Development Forum 2014 - Economic Summit" on March 22 morning held in Diaoyutai State Guesthouse. Vice chairman of the NPC Financial and Economic Committee Wu Xiaoling that balance is the treasure of high interest to the banks themselves, the commercial banks had Costly solicit depositors high interest rates, no wonder they balance treasure. Need to regulate the interbank market distortions, and solve problems from a system perspective.

Wu Xiaoling comes to Internet banking essential first need to have a common understanding, I personally think, in fact, the essence of the Internet is to use Internet banking big data cloud computing, mobile payment and other information technologies to complete the financial business, because it's efficient and convenient, making the past Many businesses and individuals are not entitled to financial services, which they provide it. But this does not change the nature of finance.

Wu Xiaoling considered from three angles to understand the original intention of the introduction of the policy of the regulatory authorities.

First, we have to consider the creation of Internet services for money is not affected. Recently stopped virtual credit card, such as Jingdong IOUs, historically, first invented the credit card business enterprises, commercial enterprises when issuing credit cards for granted in the law to give them support, but there are companies issuing credit card payment functionality, will create new currency, this is an issue we need to study. Money is paid on the deposit system. In addition, the balance of deposits to impose their treasure reserve considerations, should consider various non-bank financial institutions, what are their roles in the creation of money in the bank deposits.

Second, the third party can not be well protected safety of customer funds, regulators detect flows of capital, and maintenance of the social and economic order. If a large amount of third-party payment, then the safety of customer funds will be affected.

Third, the network of financial investment and financing behavior at the same time convenient, can well protect the interests and rights of investors, P2P, and the key to success lies in whether the public to raise the financing Information do better, improve the credit system, you can protect the interests of investors.

Regulatory authorities introduced the policy is not focused on who moved the cheese, but rather focus on what is the impact on society, financial security for investors, customers are not well protected.

The following are all of Record:

Wu Xiaoling: In recent days, the regulatory authorities have also introduced a number for the Internet financial advice, the community also preach, saying regulatory authorities what measures will be taken, how to look at these issues? I would like to take this opportunity to talk to you some of my personal views, first of all, I think we should be on the internet banking, the essence of what he is? Probably still need to have a unified understanding, because now there is that Internet banking community, but also said financial Internet, but as far as I personally come that the Internet banking, in fact, he's the essence of the Internet is to use big data, cloud computing, mobile payments such as information technology, to complete the financial business.

Because he's efficient and convenient, making the past a lot, because the cost is relatively high, many companies and individuals are not entitled to financial services provided by them out, so it caused great repercussions in the community, but this does not change financial nature, so I think it is good internet banking, internet banking or, in fact, that IT in itself a use of the financial industry, but we are willing to put the community on these points made outside of the traditional network of financial These financial business called Internet banking, so I talked about today is relatively narrow, stand at this point on this issue.

So, for the regulatory authorities, recently introduced a few policies or legends of the community, the regulatory authorities will be what kind of policies, we consider how to do? So I think from the perspective of the three regulatory authorities to understand the original intention of the introduction of the policy, right, first, that we have to consider an Internet business, in the end of the money creation function will not have any effect, because the most important group of financial organization is commercial banking, commercial banking, he most basic function, what is it? When in deposits, loans and apply for settlement, the three combined, he will create new money, this is the most essential features of the commercial banks, because he can create money, and he has absorbed a large number of public deposits therefore regulatory authorities to conduct strict supervision of his recently stopped virtual credit card payment system, such as Jingdong IOUs, he is actually a virtual credit card payment system. So how to treat this problem? It should be said in history, is the first invented the credit card business, which is the product of credit, credit card issuing business enterprises should therefore be justified, we should be given support from the law. However, a payment function to release the body of an enterprise a credit card, he will create new money? This is the question we need to study, because it is both do the settlement, while the credit card itself is a loan is a credit loan, then you pay the money on this system is the deposit, he also has the three characteristics that deposits , settlement, loans, so the money creation business in the end will have any effect, I want to carry out some research, is not it!

Then everyone is talking about a more current, that central bank officials have come to treasure for the balance of deposits in commercial banks to impose reserve requirements, I would like to consider this question is also what should be considered? Should consider the types of non-bank financial institutions, their deposits in commercial banks in the end what kind of role to play in money creation, the first few times when I interviewed said that if the policy should not be a policy on babies, should What is it? Should be the future of all non-bank financial institutions to open accounts at commercial banks on their deposits can produce what kind of effect do the assessment on this basis that the policy came out, so I think the regulatory authorities to consider the policy when the first point of departure, is that you are not generate new money, or that will have an impact on the creation of money.

The second angle is the third-party payment mechanism for convenient and efficient completion of the transaction, while the media can not be well protect the safety of customer funds, regulators, monitoring and maintenance of the flow of funds to the social and economic order. Three aspects, one is the safety of customer funds, a regulatory authority to have this flow of funds may monitor, there is the maintenance of social and economic order. In the majority of third-party payment accounts are opened weak real-name system account, a bank account in real-name accounts are strong, that he is completely real-name system, and this weak real-name system account yet, that did not Commercial Bank signed an authentication protocol, can not for the true identity of each account to make very sure of this understanding. So in this case, it is possible to have a false account, it is possible to make money inhabitants damage, or is there some illegal financial activities, then when a small amount of this money when you can basically say to individual residents will not have much damage, but also for the social order will not have much interference, so the first period, when all kinds of third-party payment agencies in this development process, regulatory authorities have not put forward any questions, Because the amount is relatively small, but then if the amount is big, once a problem, the loss of customer funds, and interference with the social order is relatively big. So how to balance efficiency and safety regulatory policies to measure, which is the second angle.

The third perspective is the network of financial investment and financing behavior at the same time easy and can not be well to protect investors' interests, and the interests of investors, which is a very important consideration, because P2P and all the reward he is in fact A direct financing, he built a platform for investors and financing directly financing his key to success lies in this platform can not be able to finance Information, authenticity, his credit assessment of credit financiers These efforts can be better, if these things do, and can do symmetric information that investors and financiers of information between them is symmetric, it can well protect the interests of investors. Thus, those who have long-term development vision of the business, enterprises and the public is P2P reward companies that they now have the next great efforts in improving his credit system, because in our country there is no complete personal credit information system and a complete collection of small and micro enterprises communication systems, P2P companies and the public need to reward companies to do this work themselves, then this is a great investment, a very difficult task. Some P2P and platforms for reward in the rush to expand public services, the pursuit of profit, he is no longer the credit rating aspects to work hard, but to do some pool of funds business, and to split the bonds and then sell the business, thus on suspicion of entering into what, into the illegal deposits and securities issued illegally, is stepping on the red line so, in this case, the regulatory authorities to warn that you can not step on the illegal deposits, disguised the illegal fund-raising. Regulatory authorities should prompt can not step in disguise illegal fund-raising deposits and the red line.

I think I just talked about these three is what I understand, the regulatory authorities in considering the policy, instead of focusing on who moved the cheese, but this business depends on money creation have any effect on customers safety security and social order, the funds have any effect on investor protection have any effect. Financial development of the Internet has been a great challenge to traditional finance should say it can be a good promotion for the traditional financial and better service in the past he does not have to provide good service to these customers.

So while we have the encouragement and financial development of the Internet, we should look down on certain principles of innovation, and some can not touch the red line, the relationship between them, we have a common principle, the basis of common principles discussed up Relationship innovation and regulation. In this case the relationship is positive interaction, I take this opportunity to say a few words, I am an idea in this regard, thank you!

Venice Votes To Leave Italy

This is a huge win because it garnered 89% yes votes, on par with what was seen in Crimea. When secession votes have this much support, they are successful.

Venice votes to split from Italy as 89% of the city's residents opt to form a new independent state
Organisers said that 2.36million, 73 per cent, of those eligible to take part voted in the poll, which is not recognised by the Rome government.

The ballot also appointed a committee of ten who immediately declared independence from Italy. Venice may now start withholding taxes from Rome.

......'We are only at the Big Bang of the movement - but revolutions are born of hunger and we are now hungry. Venice can now escape.’
The West is coming apart and it will unleash a new wave of political and economic reform, but it will be messy.

The big vote will be when a U.S. state or region (the South) votes to leave the United States.

China Preferred Shares Seen As Market Rescue Plan; Second Major Ghost City Emerges; Chinext Ends IPO Profit Requirement; Haixin Debt 5 to 7 Times Larger Than Reported

Preference shares, prescription for ailing China stock market?
According to the CSRC, the face value of one preference share in China is set at 100 yuan (16.2 U.S. dollars).

A listed company refers to one listed on a stock exchange. An unlisted public company is one that is not listed but has either issued or transferred shares to more than 200 shareholders.

According to the CSRC, three kinds of listed companies are eligible to issue preference shares, including some blue chips, companies with merger and acquisition plans, and those which perform a common share buyback to lower registered capital.

Stock market commentator Ai Tangming said the scope for eligible companies was wider than he expected, indicating that the state regulator is eager to release reform dividends to boost the capital market.

.....Investors widely predicted banking shares will be included first in the program. Banks rose across the board on Friday with the Industrial and Commercial Bank of China, the nation's largest state-owned lender, rising 1.83 percent, and China Construction Bank, the second largest, up 2.38 percent. The index tracking the banking sector jumped 4.39 percent.
Preferred shares will draw more money into the equity market, but it isn't a big enough policy to spark a jump in shares. Like in the increased ceiling on foreign ownership, it is a positive reform that raises the present value of the Chinese stock market, but the benefits are long-term while the risks are heavily concentrated in the short-term.

Elsewhere, "the renminbi may depreciate 10% over 2 years and that will lift home prices": 人民币未来两年或贬值10% 央行若降准房价将再次上涨. I believe Chinese home prices will fall in foreign currency terms and also in terms of gold. A 10% depreciation in the yuan isn't nearly enough to spark a price increase if there's a major decline.

There's some good info in the article though:
Analysts believe that the mainland real estate enterprises listed in Hong Kong a few years ago most of the debt borrowed a lot of dollars, the interest rate is usually around 8% to 10% in the appreciation of the renminbi stage, partly offset by interest rates and exchange rates. But once the tide of RMB devaluation, interest rates and exchange rates will be superimposed. Data show that only the fourth quarter of last year, the mainland real estate enterprises issued in Hong Kong more than 80 billion dollars in bonds, some small real estate bill rate is above 10%, for example Wuzhou International up 13.75 percent coupon rate. 2 percent devaluation last two months, the cost of debt means that developers will increase accordingly.
Again, the small change in renminbi is an issue, but the bigger issue is home prices. A 2% decline in the yuan isn't going to mean much versus a 20% drop in home prices.

Meanwhile, the "second Ordos" arrives in Fugu, Shaanxi: 府谷或成鄂尔多斯第二 民间借贷崩盘楼盘价格腰斩 (Fugu may become the second Ordos; Prices cut in half)
March 20 at 10 am, Fugu County, Shaanxi Province 70-80 people gathered in front of the county government, has dressed beautiful young women, there are also white-haired old man, their common goal is to collect debts.

A creditor told the "China Times" reporter, the debtor's name is Zhang Xiaoli, she operated by Hong Chang Xin Shaanxi Coal Industry Group Corporation (hereinafter referred to as Hong Chang-hsin) illegal deposits from the public up to 21 billion yuan, involving hundreds of persons. Today, not only do not pay back the money, people have been faceless. Creditors had a collective petition to the county Office of petitions, hoping the government solve the problem.

This is just a fragment of Fugu private lending collapse, starting in 2012, the private lending Fugu chain began full break, but has its roots in the local economic pillars - the coal industry's decline. Private lending collapse also caused Fugu county's credit crisis and the resulting general tightening of capital chain. In order to resolve the growing number of private lending disputes, after the Spring Festival, the county set up a fight and disposal of illegal fund-raising work of the Leading Group Office (hereinafter referred to as non-office hit).
Coal production is big in Shaanxi as it was in Inner Mongolia, where Ordos is located.

Property domino

Fugu County, a staff member told reporters that the collapse of private lending, resulting in a credit crisis Fugu city. Over the past more than ten million borrowed a phone call away, even the receipts do not have to fight. Even now borrow 10,000 yuan from relatives and friends have no one would dare to borrow, human relations indifferent.

Another civil servant, also said in the past, Fugu funds are "live", flowing, and hands every household money. Today it is fully tightened, most of them lying on the bank to sleep.

In this regard, the most sensitive reaction is the real estate industry. Fugu New "Xin Yuan toward" a real estate manager, told reporters, because the developers have capital chain tension, markdowns for the return of funds, and the intensity is still very great.

Newspaper reporter in "New One" real estate visit also learned that the highest real estate prices from 12,000 yuan / square meter, now dropped to 7000-7500 yuan / square meter, a drop of nearly half.

Price cut even trigger a chain reaction, from the "New One" near "the capital of the Golden Mile" Property owners meeting occurred just recently, the cause of the delay is the developer submitted. But the aforementioned real estate manager, told reporters that the real reason is dissatisfaction with the real estate owners refused to cut prices, take the opportunity to reject all moved.

March 19, "the capital of the Golden Mile," the sales staff also told reporters that the real estate prices are currently still 9,200 yuan / square meter, in the future it will not cut prices because their goal is to build the first new district Fugu mansion .

Chinext ends the requirement that IPO companies have been continuously profitable and also expanded the number of industries eligible to list, up from 9. 创业板IPO取消盈利持续增长要求

Haixin Steel detonation wave of defaults (海鑫引爆钢铁违约潮)
Steel industry has been the default risk of the steel trade extending to the upstream, namely raw iron ore and steel companies in the field. Latest developments is the new financial reporter informed sources from the industry, the largest private steel plant in Shanxi Haixin Iron and Steel Group Co., Ltd. (hereinafter referred to as Haixin Iron and Steel) funding strand breaks, deep debt crisis, the risk of exposure to $ 15 billion 20 billion yuan.

Informed sources told Caixin reporter, Minsheng Bank loan exposure Haixin Iron and Steel Department said the outside world is much larger than the current 3.0 billion. In this regard, Minsheng Bank President Hong Qi is not recognized. Hong Qi said that the current local government is actively involved in the matter, "(Haixin) far not reached (the debt crisis) time." Minsheng Bank to Finance Brand Management in the new official reply claimed that the current Haixin Iron and Steel Group Co., Ltd. in Minsheng Bank credit exposures 1.95 billion yuan, all of the Department of collateral loans. "I'm OK now and the relevant government departments and banks a consultation jointly resolve risks, to help companies weather the storm."

And a bonus ghost city for the future: Are China's 'ghost' cities building towards economic ruin?
More than 150 square kilometres of property floor space will be built and put on the market in the next three years, enough to house 3 million more people in a city with a population of just 4.3 million - prompting fears Guiyang will be home to China's next ghost city, alongside infamous examples in Inner Mongolia's Ordos and in Wenzhou.

1Q 2014 State of Play: Still No Sign of Inflation, But Bank Lending is Rising; QE Surprise Ending is Inflation?

A year and a half ago, I wrote State of play in Q32012: Fed and U.S. government policy is not enough to offset deflation. I've updated some figures and done some light editing, but otherwise it is unchanged because not much has changed in the U.S.

Some changes since then: many people are starting to agree with the arguments I made, originally put forth by deflationists such as Bob Prechter and economists such as Steve Keen that the money supply and money creation process are not as they appear in economics textbooks. Even the Bank of England now agrees. See: Money creation in the modern economy. Also, mentioned below are floating-rate notes from the Treasury. They have now launched (linnks below in the text).

Finally, at the very end I look at some recent data.

The U.S. national debt cannot be “inflated away” using typical policy tools, inflation is not possible without the government taking “extreme” measures, deflation remains the greatest threat and most government action will at best only cause stagflation.

U.S. national debt

In discussing the U.S. debt situation, it is first important to set the table.

U.S. GDP: $17.0 trillion
U.S. Federal Debt (hereafter referred to as federal debt): $17.5 trillion (as of March 2014)
U.S. Federal Public Debt: $12.6 trillion

The difference between the two debt figures is intragovernmental debt, such as the Social Security “trust fund.” Just looking at these numbers, we see that debt now exceeds GDP. This means if U.S. debt grows 1%, the economy must grow 1% just to keep the debt/GDP ratio constant. Currently, the U.S. is struggling to achieve 2% GDP growth and has a budget deficit of about 4% of GDP. It also means that if interest rates are 5%, the government must collect 5% of GDP in taxes just to pay interest on the debt. Historically, the federal government has collected about 20% of GDP. Put these two facts together, and the U.S. is only a few years away from debt levels that will bankrupt the government, should interest rates rise. (Japan, with government debt at more than 200% of GDP, is a disaster waiting to happen.) Without higher GDP growth, financial crisis is inevitable.

The public debt number represents all the bonds held by everything from central banks to the individual investor. The rest is owed to government agencies, mainly Social Security. As the Social Security trust fund depletes in the next decade, Congress will not have the money to redeem those bonds, so it will issue new bonds to the public, basically rolling those bonds into the public debt column. In other words, it will eventually become public debt. Legally, Congress could change the Social Security program at any time and if it wanted to, it could effectively cancel out that debt and cut benefits, but that would require a politically unpopular and improbable act.

U.S. Federal Spending: $3.6 trillion
U.S. Federal Revenue: $2.3 trillion
U.S. Budget Deficit: $1.3 trillion (FY2012 through July 2012)

The budget deficit is roughly 4% of GDP. If GDP does not grow by 4%, the debt/GDP ratio will get worse every year this large deficit remains (and despite rosy forecasts, it probably will remain). If you remember the deficit debates of the late 1980s and 1990s, there is no comparison, back then deficits that were 3% of GDP sparked outrage. Also, in the 1990s, the economy grew much faster than deficits and debt was shrinking as a percentage of GDP, even before the Republican Congress and Bill Clinton compromised and slowed federal spending growth. We are now in the opposite situation, where the growth of debt is reaching the point of escape velocity once compound interest takes over. When the government reaches the point of issuing bonds to pay interest, it will be game over.

Excessive debt slows growth

A widely cited statistic from a paper by Kenneth Rogoff and Carmen Reinhart, (whose book on government debt titled, “This Time Is Different: Eight Centuries of Financial Folly” examines the history of government debt and has made them two of the most sought after experts on the topic) says that when governemnt debt-to-GDP ratios reach 90%, GDP slows by about 1%. (Source: Growth in a Time of Debt) Some critics challenge this stat, but debt-to-GDP is now over 100% and growing at 8%-plus per annum. I think its a reasonable to assume it is now a drag on growth.

This is important because some budget control plans (specifically the widely referenced Ryan plan) assume stronger GDP growth. The longer the U.S. runs large deficits, the harder it will be to get back to 3% growth and the worse the situation becomes. At some point, the deficit reaches an unsustainable level and the government cannot slow its growth.

When will the debt become unsustainable?

The debt would be unsustainable once debt-to-GDP was high enough that interest payments consumed a large portion of government revenues. The Treasury provides us with a total interest rate on Treasury debt (Average Interest Rates on U.S. Treasury Securities), currently 2.65% (less than half the interest rate from 2001). Budgeted interest expense was $251 billion, or 6% of spending, plus non-cash interest of $203 billion for the Social Security Trust Fund, for a total of $454 billion. Far from unsustainable today, but that assumes rates stay low. (I left these figures in to show a clear comparison. Interest rates are down thanks to QE: currently (March 2014) the Treasury is paying 2.4% on all debt. Thus, interest costs are not much higher even though the debt increased by $2 trillion.)

However, as we've seen with Greece and other indebted countries, once investors believe the debt is unsustainable, it is unsustainable. Collapse comes swiftly because interest rates rise rapidly. Interest rates are currently low and appear as though they'll stay that way for a few more years; and foreign governments and central banks will likely continue to support the U.S. dollar and U.S. Treasury market, allowing Uncle Sam more time to get the situation under control. Still, as the Social Security trust fund depletes and that debt goes on the books, cash interest expenses will rise (it would be above 10% of the budget today). If interest rates doubled (not difficult from such low levels) and the debt continues to grow, interest expense could quickly become 25% of the budget.

Can the deficit be cut?

Look again at the deficit and federal spending: the deficit is close to 40% of the budget. Social Security, Medicare and defense make up about 60% of spending. Had the tea partiers won in August 2011 and stopped the debt ceiling from increasing, the government would have had to immediately cut 40% of spending―and if it refused to touch these three large programs, the rest of the government would face an almost total shutdown.

The obvious area to cut is the wars in Afghanistan and Iraq, but even President Obama believes these are important (and in his acceptance speech at the 2012 Democratic Convention, he said he wants to spend the savings). The passage of Obamacare means that, even if the wars did end, most of those savings and probably more than 100% of it, would be spent on healthcare. Furthermore, Medicare and Social Security are growing as a percentage of the budget and will grow to 100% within a few decades: simply put, unless defense, Social Security and Medicare are cut, the budget cannot be balanced. Rising interest costs on the debt will mean even deeper cuts are needed.

To put the entitlement liability into numbers, the present value of the future liabilities (if all existing programs continue unchanged) is estimated at $120 trillion, a truly impossible number. Massive cuts are coming to entitlements no matter what: they can either come early and help balance the budget, or they will come later when the government goes broke.

Also, with a high and rising debt-to-GDP ratio, the U.S. is beyond the point at which GDP growth alone can close the budget deficit.

But wait, there's more

Thus far I've only spoken about the U.S. government. What about the private sector? Total credit in the United States is about $55 trillion: The private sector has debt of almost $40 trillion, while state, local and federal government combine for more than $14 trillion (this figure uses the federal public debt number). Even if there was no federal debt, private sector debt is unsustainable and requires deleveraging because it is about 250% of GDP. This is the total of all consumer debt, mortgages, banking sector debt, etc, as shown in the chart below.

The private sector began deleveraging in 2008, as the following chart shows. Debt is being destroyed, either through repayment or default―a lot was defaulted on by banks in 2008. Many homeowners defaulted on their mortgages or credit card debt. Since 2009, much of the deleveraging has happened because people slowly repay their debt over time (each monthly mortgage payment is for interest and principal) and they have not been taking out new debt.

In contrast, federal deficit spending has offset the deleveraging in the private sector, helping push total credit market debt up about $1 trillion since 2008, to $54.6 trillion. If the federal government did not offset this deleveraging, economic growth would have been negative over this period.

Put another way, the bulk of the deleveraging took place in 2008 and 2009―the crisis―and this was stopped by massive federal government and Federal Reserve intervention. The financial sector still needs to repay or default on trillions upon trillions in debt and that's why the risk of a crash is constantly in the background―if it happens in a “disorderly” manner, we get 2008 again.

Were the U.S. federal deficit small, it could continue replacing the private sector debt, moving private debt onto the public balance sheet as it did with the savings & loan crisis at the end of the 1980s. Instead, the federal debt is already hitting unsustainable levels.

Here we reach the ultimate dilemma, the Hobson's choice. On one side is Scylla, a rising U.S. federal budget deficit that slows the economy and eventually leads to national bankruptcy. On the other is Charybdis, a contracting economy that is being propped up by deficit spending, the ending of which will plunge the nation into deep recession. There is no good choice here, the is no painless way out, there is only the choice of pain today or more pain tomorrow.

Here's a look at the historical trend in debt by sector:

Inflate it away

Hang on, critics say, there is a solution: inflation. If the money depreciates, the debt becomes smaller. For example, if inflation is 5% and real GDP growth is 2%, then the nominal GDP (inflation plus real growth) will be about 7%. That nominal growth will bring in tax revenue, lower the debt-to-GDP ratio, and the situation will quickly go back to what we saw in the 1990s, where rising revenue and slowing spending can quickly stabilize and even reverse the deficit.

It'd be great if things were that simple, but we live in a more complex world. In the first place, as noted above, most of the future deficit is entitlements―spending that adjusts for inflation and will rise sharply due to changing demographics. Parts of the federal budget will rise as fast as the CPI and inflation does nothing to address those costs. Alan Auerbach, an econ professor at the University of California, Berkeley, estimates 90% of the budget would increase along with inflation because future government spending is almost 100% entitlements. If entitlements were reformed by delinking them from inflation, then it would be easier to implement an inflation policy―but no one is talking about ending cost of living adjustments because that would be the end of their political career.

Inflation also requires trapped investors. A 30-year Treasury bond worth $1,000 today at 3.6% interest will decline in value by about 50% if interest rates climbed to 8%, because the money investors receive back 30-years hence will be greatly devalued. The problem here is that investors (including foreign central banks) don't want to hold 30-year bonds, they are increasingly holding short-term bonds of 2 years or less.

The federal government likes a short-term debt structure because it hides the cost of the deficit through lower interest rates. However, this not only makes inflating near impossible (since the government constantly has to issue new bonds), it is also extremely dangerous. Investors hold short-term debt when they fear that interest rates could rise because they get their money back quickly and can buy new bonds at higher interest rates, avoiding the devaluing scenario outlined above. Even without resorting to an explicit policy of inflation, the federal government is increasingly at risk of a bond market crisis.

This risk is similar to the maturity transformation used by financial companies. There was fear that even blue chip firms such as General Electric (GE) could go bust in 2009 because they borrow heavily in the short-term commercial paper market and continually roll it over to finance long-term projects. It is like an old fashioned bank run: your money is lent out to your neighbor for 30-years, but you want your money today. In the case of a financial firm, it borrows 30-day paper at a low interest rate and lends it out at a high rate. If people stop buying that paper, however, the firm is bankrupt.

In other words, even if a firm or country can continue in existence, if it has a lot of short-term debt and for whatever reason, investors today fear it will go bankrupt, then it will go bankrupt because it relies on short-term funding. One of the notable aspects of this type of crisis is the inversion of the yield curve. Short-term interest rates surge, while long-term rates stay lower, because the government faces an immediate financing crisis.

In sum, inflation won't reduce the budget deficit and its effect on the bond market could trigger a crisis.

This isn't news to the Treasury

Despite the government's dismal fiscal picture, the U.S. government is not run by idiots―which is why the U.S. government is considering floating rate notes. From the linked article:
While it may seem like odd timing to start issuing floating-rate debt, since most analysts predict interest rates are unlikely to get much lower, Wall Street analysts say the changes make some sense.

...For one thing, the new debt products wouldn't necessarily increase Treasury's exposure to short-term fluctuations in rates. That is because the floating-rate notes mainly would be used in place of short-term debt―bills and notes that are issued with maturities of less than two years. Treasury is constantly issuing new bills, mainly to replace maturing debt.

Issuing a floating-rate note of two years in place of a series of three-month bills also would reduce the number of times Treasury would have to sell new debt, which it does via auction. That is appealing, bankers say, especially in light of the recent debt auctions of heavily indebted countries such as Spain and Italy. Those debt sales have been nail-biting events for the financial markets.

In early August 2012, the Treasury announced floating-rate securities are coming, possibly by late 2013.
(Floating rate notes launched in January 2014.)

In adopting this course, the U.S. government tacitly anticipates the exact scenario I mention above. Taking this step is a positive move, since it shows forward thinking, but it won't make inflating the debt away any more realistic. What it does do, however, is potentially avoid a Greek-style panic in the bond market because the government won't have to rollover as much debt.

Markets allow investors to fight inflation

In addition to the government's own costs rising with inflation, another reason inflation is a bad policy: it is not an unknown. In the past, individuals had few ways of dealing with inflation and information moved slowly. Today, it is possible to hedge inflation risk instantly in financial markets. If the government tries to inflate, interest rates will go up and the cost of the debt will remain the same in real terms. If investors sense the inflation coming, they will even accelerate the inflation rate as they convert cash to hard assets and cause interest rates to overshoot as they sell bonds. The Federal Reserve would be caught between a rock and hard place, with the economy in even worse shape.

In conclusion, if the government tries to inflate, it will find itself running in place, while running the risk of destroying the currency.

Hyperinflation hysteria

Some analysts expect the U.S. dollar will hyperinflate and this will destroy the debt. Depending on the definition of hyperinflation, this could mean a range of inflation rates, but most people bring up Wiemar Germany, Hungary and Zimbabwe as extreme examples. People toss these out as examples of hyperinflation, but in reality, hyperinflation was a symptom of societal collapse, not the cause of it. Both Germany and Hungary saw hyperinflation after losing a major war. Germany experienced civil war in the post-war period, with the constant threat of communism, while Hungary was taken over by the Soviet Union. Zimbabwe engaged in genocidal war against white farm owners, destroying the nation's economy in the process. Unless you expect the U.S. to lose a major war or for civil war to breakout, there's little chance for Wiemar levels of hyperinflation.

No signs of hyperinflation

I explained how the private economy is already deleveraging and the government's massive deficits are only offsetting this force. Some people think this situation could change quickly and people will start borrowing again, but there are major factors at work: demographics, social mood and peak debt.

Aging people do not take out loans. Global inflation soared in the 1970s because the Baby Boomers were starting families, borrowing to buy homes and cars. Newly created money went right into the economy and the overall effect created a psychological impact that made everyone want to join in.

Today, it is the opposite. Boomers are retiring and selling off assets to repay debt. The psychological impact is such that even younger Americans view debt negatively and do not want to borrow. Young Americans are already bogged down with student debt. We also have a test case overseas: witness Japan's 20-years of deflation/low inflation, in part caused by a similar demographic change that started earlier.

Aside from demographics is the change in social mood. American attitudes towards debt have shifted and Americans believe the country is on the wrong track, headed for worse economic times. This does not lead people to take out loans and bet on rising asset prices.

Finally, there's the idea of peak debt. To put it into individual terms, consider the college graduate of 2012 saddled with tens of thousands of dollars in debt, who can only find low wage labor in this tight economy. This debt will hang over them for years until it is repaid, delaying family formation and home buying—two life events that drive the demand for debt.

In order to see hyperinflation, even the mild variety that doesn't require warfare or a communist takeover (inflation rates of say 50%, instead of 50,000,000%), we need to see changing attitudes surrounding debt and the economy. At first, people will become very optimistic and take out more and more debt, only later realizing that this was the start of hyperinflation.

Not only is hyperinflation unlikely, there are even signs that we have seen the end of inflation for the time being. During the hyperinflation in Wiemar Germany, the financial sector rapidly expanded and came to dominate the economy. People were paid twice a day, and they immediately ran to the bank to cash their pay check before the value of the mark fell. Bank workers almost quadrupled from 1913 to 1923. The public also borrowed heavily and bought stocks.

In the early 1990s, right after the savings and loan crisis, financial stocks made up around 7% of the S&P 500 Index (SPY). This grew to roughly 22% at the market peak in 2007, and it has fallen to 14% recently. This growth in the financial sector occurred along with the massive $50 trillion in credit created by the economy. Credit functions like money in the economy and for this reason, if there's any comparison to Wiemar Germany, it may be the growth in debt and the financial sector from 1980 to 2008.

In fact, a strong case can be made that inflation is in the rear-view mirror. While some prices are higher due to specific supply and demand situations (such as rising Asian demand and the U.S. drought lifting food prices), prices alone are not inflation. Inflation refers to the growth in the total supply of money and credit, while deflation refers to the contraction of money and credit. When total credit and money supply increase, the value of existing money and credit declines, and vice versa. It is this process that leads to a general rise or decline in prices.

Here is hedge fund manager Hugh Hendry on the topic (starting around the 7:45 market in this video: Print More Money to Avoid Bigger Slump Hendry)

"In my crazy head, in this day and age when everyone is anticipating inflation, not just inflation―hyperinflation―I'm saying to you...what if we saw it? What if we saw it between 2002 and 2007, and it wasn't the quantitative easing of the Federal Reserve, it was the mercantilistic trading policies of the surplus countries, which kind of suppressed the value, kept their exchange rates cheap and therefore created these foreign exchange reserves, these sovereign wealth funds are really just quantitative easing programs, and if we look at that 5 year period, gold broke a 27-year trend and actually went up. It went from $250 to $1000.

The dollar lost 40% of its value―40! That is one of the biggest collapses in the dollar ever. 40%. Oil went from 10 bucks to 150. (as you said) But maybe we've had all the inflation. And today, prices are falling. Retail prices are falling. And yet, everyone wants to talk about hyperinflation. I'm just curious at these...shifting players, and how they don't seem to be aligned, expectations versus reality are a little bit skewed."

Hendry has also said, “The road to hyperinflation is via hyperdeflation.” There may yet be hyperinflation, but it will occur after a period of hyperdeflation that causes world governments to enact hyperinflationary policies.

Credit creation is driven by borrowers, not bankers

The key argument against inflation is that we live in a credit economy. Most people look to the money supply when they look for inflation and they point to rising M2, but credit functions as money and the total amount of credit is more than 5 times the amount of money.

Here's Steve Keen, as Australian economist, on the subject. In a post from January 31, 2009 titled “The Roving Cavaliers of Credit”, Keen demolishes the standard model of money creation. Here are two snippets from a very long post:

Thus rather than credit money being created with a lag after government money, the data shows that credit money is created first, up to a year before there are changes in base money. This contradicts the money multiplier model of how credit and debt are created: rather than fiat money being needed to “seed” the credit creation process, credit is created first and then after that, base money changes.

Here's a grossly simplified explanation. Most people think of money creation like this: a saver deposits money in the bank and then the bank loans the money to borrowers. If the banks want to lend more money, but don't have enough deposits, the Federal Reserve can increase money supply―it prints up some money and sends it to the banks, who then loan it to people. In this model, the Federal Reserve can “create money” and cause inflation.

In reality, there are no deposits and the central bank isn't giving the banks money to lend. When you walk into a bank and ask for a mortgage, you are responsible for creating credit, and since credit also functions as money, your action, together with the bank's, creates money. Later, the central bank will create new base money to give the banks reserves, in order to stabilize the banking system.

In plain English: banks create money when they lend money to a borrower. The system is demand driven by borrowers, and the loans are the deposits.

Here is Professor Keen again:

In some ways these conclusions are unremarkable: banks make money by extending debt, and the more they create, the more they are likely to earn. But this is a revolutionary conclusion when compared to standard thinking about banks and debt, because the money multiplier model implies that, whatever banks might want to do, they are constrained from so doing by a money creation process that they do not control.

What Keen is telling us here is that banks are not restrained by regulations or the central bank. Let me explain in more detail: the way the money multiplier works, according to standard models of banking taught in most economics classes, is that when you deposit $100 in the bank, the bank has to keep an amount in reserve. If the reserve requirement is 10%, the bank (Bank A) must hold $10 for reserves and can lend $90 to a borrower. The borrower takes this $90 and puts it in their bank account (at Bank B), and that bank lends out $81 and keeps $9 for reserves. If we follow this to the end, it means the banking system can loan out $1000 dollars on $100 of deposits.

In the money multiplier system, the banks are constrained by reserve requirements and they cannot lend an unlimited amount. But Keen is telling us, this isn't how it works. Instead, the banks have no deposits. A borrower borrows $100 and this becomes deposits at another bank. Later, if deposits aren't sufficient, the central bank creates money to fill the reserves.

The central bank is following the lead of the banks, not constraining their actions. The Federal Reserve doesn't create money, it keeps the banking system afloat by lifting the money supply in concert with rising credit. The Fed is a passive actor―it needs the banks to lend, otherwise there is no money creation.

Keen goes on to explain what does regulate the banks:

However, in the real world, they do control the creation of credit. Given their proclivity to lend as much as is possible, the only real constraint on bank lending is the public’s willingness to go into debt. In the model economy shown here, that willingness directly relates to the perceived possibilities for profitable investment―and since these are limited, so also is the uptake of debt.

What limits bank lending is the desire of people to borrow. When people believe they can make money borrowing, they do so. During inflationary periods, prices of everything rise because the money supply is expanding. It is profitable to borrow money and buy stocks, houses, farm land or whatever asset is rising in value.

If Keen is right, then banks cannot lend money if people don't want to borrow. They can try cutting rates, but if people expect prices will fall, then even 0% interest loans are unprofitable. With private debt-to-GDP of 250%, the public cannot afford to finance the debt it has and wants to reduce the total. They don't want loans, if anything, they want debt relief!

It might shock you that the IMF agrees. In a recent working paper titled, “The Chicago Plan Revisited”

In a financial system with little or no reserve backing for deposits, and with government-issued cash having a very small role relative to bank deposits, the creation of a nation’s broad monetary aggregates depends almost entirely on banks’ willingness to supply deposits. Because additional bank deposits can only be created through additional bank loans, sudden changes in the willingness of banks to extend credit must therefore not only lead to credit booms or busts, but also to an instant excess or shortage of money, and therefore of nominal aggregate demand.

Now consider U.S. demographic changes and “peak” debt levels. Americans do not want to take on more debt because they cannot afford it―they are maxed out. Also, as the nation ages, more people are moving out of the peak borrowing years of middle age and into the debt repayment stage of their life. If people repay more debt than is created by new lending, the amount of total supply of money and credit shrinks.

Without credit growth, the economy is stagnant. In order for the government to create inflation in the absence of economic growth, it must offset the deleveraging of the private sector. The federal government must borrow the money that Americans won't borrow themselves.

Can't the Federal Reserve just print money?

Keep the above in mind as we travel deeper into the rabbit hole. I'm going to show you why the Federal Reserve not only isn't all powerful, it is basically a trend follower.

Most of the time, central banks follow interest rates, they do not set them! (see: De-mystifying RBA Setting of Interest Rates) Consider that Federal Reserve interest rate cuts have failed to spur the market, but in come cases, bond investors have pushed yields into negative territory (German bonds being one recent example, see: Europe: When losing money makes sense). Bond investors are willing to accept negative interest rates, but the central bankrates are higher. Even now, in the midst of unprecedented central bank policy, central bankers are following the market, not leading it!

Here's another thing you probably didn't realize. The Federal Reserve does not print U.S. dollars, it prints Federal Reserve Notes. What is a FRN? It is a debt instrument. The Federal Reserve does have printing presses, but when the Fed “creates money,” it buys existing credit paper. As in Keen's model, the bank creates credit when it makes a loan to a borrower. Later, it will sell some of those loans to the Federal Reserve, which will give it FRNs to hold as reserves.

Previous to the crisis, the Fed would mainly buy U.S. Treasuries from banks. After the crisis, the Fed started accepting other debts of much lower quality in an effort to support the banking system.

As Steve Keen as shown, the standard model is completely wrong. The Fed isn't creating new money, it is back-filling the already created credit money. If we imagined a world with no new debt, the Fed would have nothing to buy and would be unable to create any new money. The Fed is entirely dependent on the willingness of banks to loan, and the banks are entirely dependent on the willingness of borrowers to borrow, a total reversal of what is taught in standard economics classes and textbooks!

However, the U.S. government to create inflation. The U.S. government is also a borrower and if it decides to spend vast sums of money, it can print Treasuries and sell them to the Federal Reserve, which will give them FRNs they can use to buy goods and services (or just mail checks to everyone).

But, you may be thinking, why can't they just print paper money? They can't, not physically and they won't, because they don't want to. The Federal Reserve published its 2012 New Currency Budget, and it shows no ramp in currency printing and no plans for it. There's no sign of a plan to create a sea of paper money. As for their plans, consider that the $500 and $1000 bill (and even higher denominations) were taken out of circulation decades ago. Governments are increasingly moving towards digital currency because it cannot hide. Drug dealers starting switching to the euro a few years ago because the euro has a 500-euro note, which means more cash can be moved physically via euros. There's no evidence of government plans to return to a cash economy. Printing cash would generate inflation: in a cash economy, if I borrow $1000 and then default, the $1000 in cash is still in the economy. But in today's credit based economy, when I default, the $1000 is destroyed.

The Federal Reserve could credit everyone's bank account with money. They could add a zero to every account and devalue the U.S. dollar by 90%. However, this is another extreme solution, something never before done by the Federal Reserve. It would require a political decision in Washington, D.C.

An estimate of the required deflation

There are many ways to estimate how much the Federal Reserve would need to print in order to create inflation. One way is to consider the ratio of credit money to M2. Assuming the economy will return to its “starting position” in 1980, when base money (M2) was one-third of credit money, the economy either needs to deleverage $25 trillion or the Fed needs to print $8 trillion. I do not hold this out as a definite estimate, but I believe these huge numbers are reflective of the depth of the current crisis.

Are there any solutions to the debt crisis?

If inflation isn't a solution, the only real solutions are cutting government spending and wiping out the debt, because spending and debt are causing the problem. The choice is between voluntarily cutting spending and wiping out debt, with the benefit of long-term planning, or waiting for a market panic that requires instant cuts, with little time for debate.

The death of the dollar is greatly exaggerated

Since there's no sign of spending discipline anywhere in Washington, D.C., many people expect the death of the U.S. dollar. If the dollar did die, it would collapse rapidly, leaving no time for people to adjust. Instead of inflation over the course of years, all the inflation might happen in a week or month. The price of oil would shoot to $200 a barrel, gold would go to $10,000 an ounce and that would be it for inflation. Americans' standard of living would drop, they would be unable to import foreign goods and American goods would be very cheap, driving an export boom. It would be similar to the collapses seen in the Asian Crisis, Russian default and elsewhere.

As mentioned above, however, the government already anticipates potential market crises. If those in charge want to stay in power, they will certainly defend the currency, in any event, U.S. finances are not yet as bad as Greece's.

And that brings up a major ace up the sleeve of Uncle Sam. Europe (with a bigger welfare state and worse demographics) and Japan (the worst demographics and government debt-to-GDP above 200%) are likely to collapse first and in every instance thus far, panic means U.S. dollar and U.S. Treasury buying (even last year's downgrade of U.S. Treasuries led to lower interest rates as investors panicked).

Until the crises around the globe play themselves out, the U.S. and the greenback are safe by virtue of being the healthiest horse in the glue factory. Besides investor buying, the world relies on the U.S. dollar as reserve currency and therefore almost all governments and central banks work to support the dollar. Exporting nations in Asia and South America also do not want a weak dollar because it will damage their economy. When the Federal Reserve launched it's second round of quantitative easing, the Brazilian finance minister complained of a “currency war.” Nobody wants to see a very weak dollar and the loss of the dollar as reserve currency because the entire global economy is built on a the dollar.

Finally, only the U.S. has large and liquid stock and bond markets. The eurozone was a potential competitor, but we see how that is going. Other nations are too small. Consider the plight of a major financial center, Switzerland: the country instituted a peg with the euro because so much money flowed in to Swiss banks, it forced the franc higher and threatened to kill the Swiss economy. The only market that can handle a massive global wave of money is the United States.

The U.S. can use these strengths to kick the can and delay the crisis, or it could make use of the cheap debt to reform, but the death of the dollar won't arrive until the situation is so bad that nothing can delay it.

As an aside, this is why $5,000 price targets for gold are not crazy and why many analysts have very high price targets for gold, such as $10,000 or more. If the U.S. dollar did fail as a safe haven, a lot of money would rush into very, very small markets by comparison, including gold. I don't expect those high gold prices in the near future because I see the dollar holding up, but the logic is sound.

Ending the dollar as reserve currency

I doubt the U.S. could achieve a major bout of inflation without ending the U.S. dollar as reserve currency and replacing it with gold. One way to achieve a rapid devaluation of the dollar, while maintaining some control over the global financial system (desired by the politicians), would be for Federal Reserve (or U.S. Treasury) to devalue the U.S. dollar against gold. The Fed would step into the market and announce that it would pay $5,000 (a low estimate for a gold revaluation) per ounce of gold. They would choose a price at which the U.S. 8,000 tons of gold is large enough to dominate the market and offset government debt levels. Currently, U.S. gold is worth about $400 billion (at $1600 an ounce), so a move to $5,000 would increase the value to about $1.3 trillion.

Jim Rickards, in his book Currency Wars: The Making of the Next Global Crisis , outlines a fictional scenario where the Russians decide to launch a gold currency to weaken the United States by damaging the U.S. dollar. He argues that a scenario such as this is increasingly likely and that the U.S. should choose to use gold, rather than have it forced upon them. He has also dubbed the United States the “Saudi Arabia of gold” due to its holdings, the largest in the world.

Gold can handle it

Gold is already becoming the safe haven of choice because if the dollar fails, the entire global financial system will collapse, meaning no currency is safe. Any country with a favored currency would see their economy collapse if they allowed it to appreciate (see the Swiss reaction to the decline in the euro), so they would all depreciate their currencies in response. In contrast, many central banks still hold literally tons of gold and no one would need to stop “hot money” from flowing into gold because it wouldn't be as disruptive to the economy.

Think of it this way: if Chinese yuan is 6 to $1, and a pen costs 6 yuan, it also costs $1 for an American.

Now, what happens if China's currency collapses to 600 to $1? Suddenly that pen is very cheap and everyone in America would buy as many as they could. So when we see a single currency depreciate against others, it's goods and services become very cheap, and other economies exports become very expensive, causing massive economic disruption.

What happens if everyone devalues against gold? The price of gold rises in dollars, euros, yen and yuan, the relationship between the currencies will not change as dramatically. Gold can act as a pressure valve because it can absorb capital inflows without as much economic disruption.

Revaluing against gold also takes away the desire for a safe haven by folding it back into the U.S. dollar and the global financial system. Instead of thinking of how to protect their assets, investors would invest their money, with many gold holders selling their gold to collect their profit. However, while a number of advocates for monetary reform have suggested revising gold's role, they remain on the fringe in Washington, D.C.

Debt wipeout

Another possible scenario is a debt jubilee. Taken from the Biblical jubilee, where every 50 years slaves were set free and debts canceled, a modern jubilee (as proposed by Steve Keen) would have the government or central bank send a certain amount of cash to every citizen. The money must be used to pay down debt, but if a person has no or little debt, they would receive a cash infusion to their bank account. This is similar to the Federal Reserve's quantitative easing program, but the money would go directly into the economy.

For example, let's say the government sends every American $50,000. If you have a mortgage of $100,000, your balance is cut to $50,000. If you owe $25,000 in student loans, you are debt free and have $25,000 to spend. If you are debt-free, you receive $50,000 to spend as you please. It would be a quantitative easing program for the people, not the banks, and it would cut debt levels massively by wiping out debt and devaluing the currency simultaneously.

The worst case

I don't call this a solution, but it would eliminate the debt―the U.S. government goes full banana republic and starts spending even vaster sums of money, printing the cash to pay for it. The federal government would “print” Treasury bonds and sell them to the Federal Reserve, which would give it cash to spend into the economy. Or the government would simply have the U.S. Treasury directly spend into the economy. The government wouldn't worry about taxes anymore, it would simply print money and spend it.


Hyperinflation is unlikely without an explicit political decision. The two cases of hyperinflation during U.S. history occurred during the Revolutionary War and the Civil War. The historical evidence from around the globe supports the hypothesis that a government must collapse, be feared to collapse, or engage in willful destruction of its economy (Zimbabwe) in order for its currency to become completely worthless.

This doesn't rule out high rates of inflation, but as I explained above, deflation is far more powerful today and without an “extreme” and explicit policy of inflation, it's unlikely there will be any. Even if there is inflation, it doesn't get the U.S. government out of its debt problems or impossible entitlement spending estimates.

The most likely course is the one we are on: global central banks will hold deflation at bay for as long as possible, until they cannot and global investors send the markets lower once again. I do not expect a Japan scenario for the West, it will be far messier because the culture and political systems are more volatile.

Even if the deflation scenario wins out, inflation becomes more and more likely with each passing day. Governments always act far too late: the U.S. government passed Glass-Steagal after the Great Depression; they repealed it at the top of a 20-year bull market; they passed Sarbanes-Oxley after Enron went bankrupt and Dodd-Frank after the 2008 crisis. In security, the U.S. upped airline security after 9/11; they made passengers take off their shoes after the shoe bomber passed security; they started doing full body checks after the underwear bomber was discovered, etc. If there is ever an explicit policy to inflate, it will almost certainly come after a major deflationary wave has wiped out enough debt to reboot the economy―and therefore will come at precisely the wrong time.

For this reason, it makes sense to hold some gold. I expect that even if spot gold prices tumble during another 2008-style crisis, it may be hard to obtain physical metal as premiums rise (this happened during the first phase of the 2008/9 decline). Once an inflationary policy is announced, gold prices will take off. There may only be a very small window, if any, for investors waiting for the last possible moment. And should world governments choose to reform the global monetary system, it will likely include revalued gold. 

2014 Q1 Update: Still no signs of inflation. As the Billion Price Project at MIT shows,

While the CPI is under counting inflation, there is not a huge discrepancy. There is little inflation because credit growth remains stagnant. However, the latest Z1 Report from the Federal Reserve did show a pickup in credit growth and this is a chart (click it for a much larger version) worth watching:

If this trend in loans keeps up, this could lead to inflation later this year. One reason why lending may have been depressed is due to QE: banks are not adequately compensated for the risk on their loans. Notice lending picks up right after the Fed announced the first taper. It takes time for credit to work its way into the economy, but results should arrive in the next few months. The end of QE may be the trigger for inflation, depending on what happens with the trillions in reserves sitting with the Fed earning 0.25 percent interest. The end of QE could lead to faster money creation. This is speculative and the spike in lending could be a blip, but it would explain a continued rise in credit growth as interest rates move higher and the Fed tapers. It is worth remembering that interest rates rise along with inflation because real interest rates are falling during this period. I still think deflation wins the day, but if I am wrong, I think this scenario is how things will play out.

All of this analysis is U.S.-centric. China is currently experiencing a monetary tightening and mild deflationary period that could morph into something larger. If there is more deflation, the U.S. debt problems will grow worse and the Fed will lapse back into QE, setting the stage for yet larger inflation once policy is normalized.