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"Ignore This Measure Of Global Liquidity At Your Own Peril", Albert Edwards Warns

With all eyes squarely on the ECB as Mario Draghi prepares to flood the EMU fixed income market with €1.1 trillion in new liquidity starting Monday, Soc Gen’s Albert Edwards reminds us that “another type of QE” is drying up thanks largely to the relative strength of the US dollar. The printing of currency to buy US dollar denominated assets in an effort to prop us “mercantilist export-led growth models [is] no different to the Fed’s QE,” Edwards says, explicitly equating EM FX intervention with the asset purchase programs employed by the world’s most influential central banks in the years since the crisis. 

Via Soc Gen: 

Clearly when the dollar is declining sharply, global FX intervention accelerates as the Chinese central bank, for example, needs to debauch its own currency at the same rate. Conversely, when the dollar rallies strongly, as is the case now, FX intervention rapidly dries up and can even reverse, exerting a massive monetary tightening on emerging economies and ultimately the entire over-inflated global financial complex... 

 

The swing in global foreign exchange reserves is one key measure of the global liquidity tap being turned on and off ? with the most direct and immediate effect being felt in emerging economies.

Given the above, we should expect to see global foreign exchange reserves falling…

… with the most pronounced move in EM reserves…

Edwards goes on to note that even as China dials back the market’s expectations for Chinese GDP growth, a look at the variables that Premier Li Keqiang himself has said are a better proxy for economic growth in the country (electricity usage, rail freight volume, and credit growth) suggest GDP growth in China may actually be running below 4%...

… and Chinese industrial profits paint a similar picture…

One problem, Edwards notes, is that the yuan’s dollar peg and easing efforts aimed at devaluing the currency are currently working at cross purposes: 

We have long believed that China?s growth and deflation problems will necessitate a devaluation of the renminbi in a strong dollar environment. There is mounting evidence that this process may already be underway as the currency falls to a 28-month low against the dollar…


In the current deflationary environment the Chinese authorities simply can no longer tolerate the continued appreciation of their real exchange rate caused by the dollar link.  

Indeed, the currency’s REE looks to be closer to $5.60… 

…and according to Barclays, the yuan is the second most overvalued currency in the world…

The solution, Barclays notes, is devaluation: 

As the USD has risen against global currencies, the market has likely become more concerned that China eventually will have to allow more CNY weakness versus the USD in order to tame REER appreciation. As we argued in CNY:Deflation, downturn and the deepening monetary dilemma, 12 February, amid slowing inflation and rising outflows, the costs of limiting CNY weakness are growing – including the unintended effect of placing more stress on CNY market liquidity and interest rates, rendering liquidity easing efforts less effective.

But it’s not nearly that simple because, as we said Friday, excessive devaluation at a time when corporates are increasingly choosing to hold their export profits in currencies other than the yuan may hasten capital outflows. The irony of course is that failing to act aggressively to arrest REER appreciation risks cutting into those very same profits or, as we put it previously, “devalue too much, and the capital outflows will accelerate, not devalue enough, and the mercantilist economy gets it.” We know where this ends: 

...an ongoing deterioration in Chinese economic conditions, coupled with a weaker, but not weak enough, currency, will result in the PBOC first going to ZIRP, and then engaging in outright QE.

In other words: more cowbell. 

So while the PCOB joins the global central bank race to the bottom, the stronger dollar will ultimately mean that the liquidity tap is cut off for EMs across the globe. 

Here’s Edwards again:

The bottom line is that in a world of over-inflated asset values, the strength of the dollar is resulting is a rapid tightening of global liquidity as emerging economies (and indeed the Swiss) stop printing money to buy the US dollar. This should be seen for what it is ? a clear tightening of global liquidity. Traditionally these periods of dollar strength are highly disruptive to emerging markets and often end in the weakest links blowing up the entire EM and commodity complex ? and sometimes much else besides! Investors ignore this at their peril. 

We leave you with the scariest chart of all, which shows an anomalous (to an epic degree) decoupling between EM asset prices and global FX reserves: