China’s Big (If Subtle) Warning to the U.S.
By now everyone knows about the big confab in China, the once-in-every-five-years event in which the Communist Party sets its goals for the next five years and beyond. In odd-numbered years, like this one, the selection of China’s future leaders is typically the crowning achievement. This year, though, a striking takeaway was that China’s future leader – and note, I’m not bothering to use the plural “leaders” – will likely be its current leader: President Xi Jinping.
Okay. So China is headed by a strongman likely to hold onto power for a decade or more. What does that mean for investors, for whom China is ever more the most relevant factor in what our markets do? Where does Xi want to take China, and how does he see China and the U.S. interacting? Xi’s own three-and-a-half hour speech at the congress provided no direct answers to those questions.
But that’s not so surprising: when it comes to China, often the only way to get to the real, underlying message is by looking for anomalies. The honchos in China measure virtually every word. When words spoken one moment don’t match words spoken a short time earlier, I call that an anomaly – a pop-up window into what the real message may be. And in this case, the most revealing anomalies can be found not in Xi’s address but in the words of someone else at the congress, Zhou Xiaochuan.
Putting the West on Notice
Zhou has headed the People’s Bank of China for the past 15 years (a record tenure). He is one of the world’s smartest policymakers and has been a key figure in the Middle Kingdom’s ascendancy this century. At the congress, Zhou made comments that I see as putting the West on notice to expect major changes in the world’s currency relationships. But he did so in a subtle way that left the West likely to overlook this crucially important message, as indeed it has. What Zhou said was:
“If we are too optimistic when things go smoothly, tensions build up which could lead to a sharp correction, what we call a ‘Minsky moment.’ That’s what we should particularly defend against.” It was a remark that John Authers of the Financial Times called “as close as someone in Mr. Zhou’s position can come to yelling ‘fire’ in a crowded theatre.”
Minsky was an economist best known for arguing that a drawback of capitalism is that it allows for the build-up of debt, which in turn can propel asset values to unsustainable heights leading to the bursting of bubbles and the distressing aftermath. Clearly 2008 stands out as a Minsky moment.
Now maybe Zhou was talking only about China and its debt, which was the Western financial press’s interpretation. But at a G20 meeting only a few days earlier, Zhou made clear that he saw China as on a path of strong, sustainable growth that would put its economy on far firmer footing.
He said then: “Fiscal revenues continued to grow, and prices remained stable. Moreover, deleveraging efforts have yielded early results, while economic growth continues to improve in terms of structure and quality, indicating China has made strong progress in restructuring the economy.”
These are hardly the comments of someone worried about a “Minsky moment” at home. If anything, the PBOC chief was arguing that China was moving away from Minsky.
It was Zhou’s comments at the congress, however, and not his earlier remarks at the G20 gathering, that drew attention from the Western press. Bloomberg and other financial press outlets headlined them and interpreted them as Zhou pointing to risks in China’s own economy.
John Authers in his opinion piece for the Financial Times said: “Invoking Minsky at the congress itself was the earliest possible point to send the message, and a sign of urgency.” In other words, ignoring what Zhou had said just a couple of days earlier, Authers pushed the view that China remains in a lot of trouble and will need to take heroic steps before its growth can be considered secure.
Zhou did make references at the congress to China’s corporate debt, which the IMF said had risen to 166 percent of GDP in 2016 from 131 percent in 2012. But he said corporate debt was inflated because local governments had used state-owned enterprises or other corporate vehicles to raise money. That debt, he said, should have been classified as government debt – which is insured and not very high to begin with.
Zhou then said, “We should seriously deal with and prevent the unhealthy use of financing vehicles and various debt-taking tools by local authorities.” As I noted above, however, just a few days earlier he had said China was making progress in these areas. But investors and analysts are so focused on China’s problems that they were all too quick to settle on an out-of-context interpretation of the central banker’s assessment.
Supplanting the Dollar
My bet is that Zhou knew exactly how his remarks would be read in the West and that they would reinforce what so many Western analysts are prone to believe, that China is tottering. And if they see China as vulnerable, these analysts won’t consider it a big deal when the country starts trading Eastern oil in yuan backed by gold – which I have long been convinced it is planning to do as an initial step in implementing a gold-centric monetary system that will start to supplant the dollar. And these plans, starting with a new Eastern oil benchmark, truly are a very big deal.
So I see Zhou’s warning of a Minsky moment as directed not at China’s leaders so much as to U.S. policymakers. John Authers came close to realizing this when near the end of his article he commented:
“Writing in the 1970s, as Keynesian economics had gone badly wrong, Minsky wanted to argue that Keynes had been badly misinterpreted, and that control over inherently unstable banking and investment was necessary if capitalism was to work.” And in a direct quote from Minsky: “Socialization of the towering heights is fully compatible with a large, growing and prosperous private sector.”
Given these quotes, it isn’t stretching the point to believe that Minsky would likely be comfortable with the Chinese model that lets a form of capitalism flourish while the government controls the “inherently unstable banking and investment” industries. For evidence Minsky could add that according to Bloomberg and others, China’s balance sheet is much stronger than America’s. For China about 80 percent of total debt is backed by bank deposits compared with 35 percent in the U.S.
Zhou’s messages haven’t always been so subtly dual-purposed, as can be seen in a brief paper he wrote in 2009. He began by asking “what kind of international reserve currency do we need to secure global financial stability and facilitate world economic growth…Theoretically, an international reserve currency should first be anchored to a stable benchmark…. Its supply should be flexible enough to allow timely adjustment according to the changing demand.”
He goes on to offer a possible example: “Back in the 1940s, Keynes had… proposed…an international unit named ‘Bancor’, based on the value of 30 representative commodities….The collapse of the Bretton Woods system…indicates that the Keynesian approach may have been more farsighted.”
A Bold Initiative
In the same paper Zhou also indicated he was in favor of giving a greater role to a basket of currencies such as the SDR, a role similar perhaps to that envisioned for the Bancor. “Special consideration should be given to giving the SDR a greater role.” Perhaps completing the picture, he noted:
“The creation of an international currency unit, based on the Keynesian proposal, is a bold initiative that requires extraordinary political vision and courage.”
This characterization – vision and courage – seems to me an exhortation to all world leaders to come together. I would guess that China’s vision of a new reserve currency would have a gold-backed yuan just as an initial step. The end goal would be a basket of currencies that would include gold and that might be backed by a basket of commodities a la Keynes and at least partially managed via a complex blockchain.
In such a system gold would likely float against the other basket members and clearly emerge as the component that balances supply and demand. This implies a value for gold that is eventually exponentially higher than today – especially as commodity scarcities emerge, which to me seems a near certainty in a growing world. So to answer the question posed at the top of this article about what the Chinese congress means for investors: one mess that can be gleaned is that gold will be rising sharply, and that all investors should have a stake in the metal.