China is doomed. Its economy will fail, and the political leadership will be cast asunder in a leaderless revolution that could result in the deaths of millions of people.
Just last night, on the eve of hosting the world’s leading central bankers, the Shenzhen Composite Index fell 7.34%. This drop took back most of its 10% dead-cat bounce over the last month.
China faces a cyclone of headwinds both in the short term and in the long.
This week, almost 1 trillion yuan in repurchase agreements are coming due. At the same time, the People’s Bank of China pulled 455.5 billion yuan of short-term loans out of the market last week.
These movements have stoked fears of a liquidity crisis and pushed short-term rates higher.
There are mounting risks for Chinese banks and insurance companies. You might remember these themes from the Lehman Brothers and AIG crisis in 2008.
Short-term rates go up, LIBOR prices jump. Firms don’t trust each other and stop lending. Loans don’t get rolled over. The wrong Jenga piece is pulled, and then the whole kit and caboodle comes clattering down.
Currency Pegs and Revolution
The thing is, China isn’t as lucky as the U.S. It doesn’t have a floating currency; it has what is called a currency peg. This means it is linked to the dollar at 6.5 yuan to the greenback.
The problem is that the dollar has appreciated 35% over the past two years. It is a great time to buy Spanish vacation houses if you are American. But it is bad if you rely on export growth as a social contract.
To cover the strong dollar, China needs to drop its currency to around 8.5 to the dollar. This will also make it easier to cover the large internal debts in the country. In 2014, China had an official total debt-to-GDP of 282%.
That’s the highest of any advanced country and is severely undervalued due to the country’s large shadow banking industry.
The problem is that China imports a lot of food and its economy is the slowest it has been in 25 years. In 2005, the country imported $10 billion worth of food. In 2014, it was $482 billion. All the while, the amount of arable land per population has dropped to 20 acres per 100 people.
Food Riots
According to Geoffrey Crothall of the Hong Kong-based group China Labour Bulletin, there is a bull market in labor protests.
Its data shows that in December and January, there were 774 labor strikes across China, up from 529 in the previous two months. Most of them were because workers didn’t get paid — sometimes for a year.
Strikes doubled in 2015 from 2014 and are still growing.
Information is hard to come by, but we know that factories are closing. Real estate builders aren’t paying workers.
There are massive layoffs in the coal mines — 100,000 workers at Longmay Group have been fired.
According to Business Insider, last year, the Middle Kingdom spent $125 billion on riot gear. Its first response to unrest has been a show of force.
We know — and believe me, the Chinese leadership knows — that the one thing that leads to revolution is the lack of food.
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Rock and Hard Place
China has a choice between lowering the yuan in an effort to boost exports and lowering internal debt obligations and spiking food prices, which would cause more unrest.
Furthermore, many companies over the past two decades have moved production to China and have benefited from rising yuan values.
Now that no one wants to own yuan, the specter of civil unrest coupled with a draconian police reaction means that few companies will relocate to China today.
This is why the smart Chinese started buying real estate at inflated prices from Sydney to Vancouver. They know the yuan will fall and hope that real estate will hold up (this trend has also peaked, but that’s another article).
No Yuan Wants
The yuan will return to its old peg of 8.3 to the dollar, but it won’t stop there. Currencies, especially pegged currencies, have a way of dropping farther and faster than you’d think. Falling currencies lead to revolution as people see their jobs disappear, their life savings vanish, and their kids go hungry.
The list of broken pegs and fallen governments is long — South Korea, Brazil, Venezuela, Indonesia, the UK, Greece, Egypt… heck, even Switzerland shocked the world when it blew up its currency peg a few years ago.
The Communist Party’s primary basis of legitimacy, its social contract, has been that continual delivery of prosperity. People have traded freedom for prosperity.
Without prosperity, the only remaining basis of legitimacy is nationalism, and when that fails, all hell breaks loose.
All the best,
Christian DeHaemer
Check us out on YouTube!Christian is the founder of Bull and Bust Report and an editor at Energy and Capital. For more on Christian, see his editor’s page.
